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Per-Share Price vs. Market Cap

Many beginning investors consider the per-share price of a stock as an indicator of its value. However, this is not the case.

If you are to apply a fundamental analysis in evaluating a stock you consider purchasing, per-share price is almost of no use.

The uselessness of a per-share price in fundamental analysis stems from the fact that stock prices are very dynamic in their nature. Additionally, every company holds a different number of shares outstanding. As a result our ability to gain an understanding of the real value of a company is much hampered.

In order to determine the value of a company, we should identify its market capitalization (also known as market cap).

market cap = per-share price x outstanding shares

The market cap represents the money you will need in order to buy the whole company on the open market.

Many times a stock that costs $40 is stated to be cheaper than a stock priced $15. Consider the following example to see why this is so.

  Stock A Stock B
Stock Price $40 $15
Outstanding Shares Number 30 million 400 million
Market Capitalization $1.2 billion $6 billion

As you can see, even though the price of stock B is lower than the price of stock A, its market cap is higher. Therefore, the stock price alone doesn't tell you anything about the value of the company in itself.

However, the market capitalization does convey a meaning. When deciding on the investment in a particular stock it should not be evaluated out of the context. You should also compare the stocks of companies of the same size and industry. Generally, stocks are divided according to their size into small cap, mid cap and large cap. Different numbers are assigned to the different categories by the analysts.

When you attempt to put in balance your investment portfolio, market cap is applied in the stock screens.

Final Piece of Advice

Market Capitalization represents a better choice when evaluating a stock. Per-share price many times is useless because it may be misleading in assessing the real value of a company.

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