Today, you’ll learn does market cap equal valuation.
- Shows the current valuation of the stock
- Determines the attractiveness of the current price
- Shows the growth prospects of a company
- Example Strategy
The company’s market cap shows the current valuation, determines the current price attractiveness and shows its growth prospects.
It is often neglected by traders considering that they focus only on the price of the stock.
The price of the stock can be studied using technical and fundamental analysis.
Technicians often rely on stock charts, while fundamentals get information from ratio analysis.
Ratio analysis usually includes Price-Earnings, Prices to Sales, and Price to book ratios, mostly with popular or High Market Cap companies.
However, companies with high Market Cap may not have higher prospects of growth considering their current value.
The growth of the stock price is often affected by the current sentiment of the market participants.
They can value a company for $800 million or $50 billion.
The value is usually not based on one valuation technique.
What is Market Cap?
According to Fidelity, Market Cap or Market Capitalization is the total value of all the company’s shares. (source)
It is derived by multiplying outstanding shares to the current price.
Current price times Price-to-sales is also the Market Capitalization.
Market Capitalization is important when comparing the relative size of companies.
Companies are often grouped into large, Medium and small cap.
It is often popular to buy only stable companies often found in the large-cap category.
However, is it good to buy high market cap companies?
The answer is not really popular among stock traders today.
But it should be studied properly to form a reliable conclusions.
Conclusions based on actual observations is difficult to find, considering the vast information that are available online.
Is it really possible to estimate the value of a company?
There are many valuation models that can be used by long term traders.
They can estimate the future cash flows of a company and discount them to estimate value.
Is there really a safe model that can provide large margin of safety?
The margin of safety may be estimated by using the market capitalization of a company.
However, the method will be different from all information available online.
The method is unique considering that common sense is usually required.
Shows The Current Valuation of the Stock
Market Cap is the current market value of a stock.
All the market participants value the stock, and they can be either right or wrong.
Being right usually makes people happy, considering that they make money when the price goes up after they bought it.
The price is misleading when used alone because traders don’t really know if the stock is expensive.
For example, is a $9 stock good or bad?
Is it better to buy $1 dollar per share companies?
This question can be answered by using the market cap concept.
The concept is simple to apply in the stock market.
As an example, a $50 billion is more expensive than a $5 billion company.
The latter may be priced by the market at $100 per share, while the former can be $10.
Which of the two companies appears to be cheaper or expensive in price?
$10 per share companies may look cheaper which is actually wrong.
It is wrong because the market cap is the current valuation of a stock.
Valuation is important for long-term traders because they want to hold stocks at least forever.
It is forever because it can be 5 to 20 years or more.
However, how can one have enough confidence to hold a stock that long?
Determines the Attractiveness of the Current Price
Traders may scan the universe of stocks by market cap multiple.
The multiple can be Price to sales and Price to earnings.
Price to sales can be used to find bargain stocks.
For example, a ratio of two means the stock is trading at two times sales.
However, two times sales is difficult to find in this era.
It isn’t easy because most stocks are trading at premiums because of growth prospects.
However, growth can still be found in bargain stocks.
Bargain stocks are usually trading below their liquidation value.
Although it is trading lower, if the profit margin can improve, room for growth may also exist.
Growth is actually important when trading for the long-term.
Long-term trading requires having confidence in a stock.
Confidence will help traders hold shares of stocks despite the volatility.
The volatility may push the stock price up or down.
However, secrets exist in the stock market, and people may not realize it earlier in their trading careers.
Trading can be easy considering that market cap does equal valuation.
However, this valuation technique is different from what is popular online.
It is based on common sense and anyone can use it considering that it requires a lot of patience.
Shows the Growth Prospects of a Company
How many companies in the United States are above the $50 billion market cap?
A $50 billion (Market Cap) company that grows 10% per year is about $117 trillion in 10 years.
How many stocks in the United states that are valued above $1 trillion?
Yet, traders still believe that holding large-cap stocks is going to grow their accounts.
Growth is limited for too big companies and being wise is better for people.
Being wise is seeing the reality of the stock market.
The stock market is designed to extract money from the less informed.
Being informed means to stay away from most valuation models and do what the rich are actually doing.
Let me introduce the concept of spawners.
Spawners are actually the long-term traders’ secrets.
The secret is to look at the market caps of the companies in the stock exchange.
Identify large, medium and small caps companies.
Select the companies having the best chance of growth.
However, this strategy is not popular and it requires a lot of research.
It does not work all the time, considering the stock selected may not be a real Spawner.