Market Cap

See the kids just getting out of school
They can't wait to hang out and be cool
--The Go-Go's

Recently we discussed valuation--the process of determining how much a security is worth. Once you estimate the security's 'fair value,' then you need to compare your estimate to the current market value to judge whether the security is fairly valued, overvalued, or undervalued.

How to obtain the current market value of a security? If that security is a stock, then current market value can be readily found by determining the stock's market capitalization, or 'market cap.' Market cap is calculated by multiplying the current share price by the number of shares outstanding (sometimes called 'float'):

market cap = price per share * number of shares outstanding

Let's use Target Corp (TGT) as an example. This morning, TGT shares are trading around $81.50. Currently, there are 512.3 billion TGT shares outstanding. TGT's market cap is:

$81.50/share * 512.3 billion shares = $41.8 billion

This is the value that the market currently places on the entire company. Suppose that you and I wanted to buy Target--not just a few shares but the entire company! To do so, we would theoretically have to write a check for $41.8 billion in order to take all shares off the market at the current price. (In reality, we'd probably have to pay more because shareholders, once they recognize that their company is a buy-out candidate, usually demand a premium over current market price before they are willing to part with their shares).

Market cap offers a decent idea of what the market currently thinks the company is worth.

A close cousin of market cap is enterprise value. Enterprise value tweaks market cap by factoring in a company's current cash and debt levels. Here's how it's found:

enterprise value = market cap - cash + long term debt

Let's return to the TGT example. Target's most recent quarterly balance sheet indicates cash equivalents of $1.2 billion and long term debt of $11.3 billion. TGT's enterprise value, then, is:

$41.8 billion - $1.2 billion + $11.3 billion = $51.9 billion

Technically, enterprise value provides a more accurate estimate of current market value because it takes into account a company's net cash position. When a company is carrying more debt than cash like Target currently does (a very common situation in today's world, btw), then the check that we would have to write to purchase the entire company conceptually increases because we would have to assume the debt obligations currently on Target's books.

Which one to use--market cap or enterprise value? While enterprise value provides a more technically correct estimate, the practical differences can be pretty small. In everyday market machinations, market cap is the more popular metric. It is widely reported--probably because it is easier to calculate. I pay attention to both and like to have a general idea of where market cap and enterprise values stand for the companies that I follow.

In market lingo, companies with market caps of $10 billion or more are often referred to as 'large caps.' Those with market caps between $1 billion and $10 billion are called 'mid caps.' Companies with market caps of less than $1 billion are deemed 'small caps.'

For reference, here's a list of the 50 largest US companies by market cap. Quick quiz: What company currently holds the title as the largest US company by market cap?

position in TGT