Clarifying the meaning of market capitalization?

Question

I'm new to this kind of topic and I'm trying to get a deeper understand. I read that "the shares' price times the number of shares outstanding is the value of a company (=market capitalization)".However, I'd say that it's just the value of that part of the company that is in the stock market. In other words, when a company issues an IPO, it might not issue ALL of its shares, but just some of them.So, let's say that the total amount of shares of a company (A) is 1000. The outstanding shares are 300 at the price of 10\\$. The market cap is 300x10=3000\\$. This number is the cumulative value of all the issued stocks.Let's take this a bit further by taking another company (B). The second company has a total amount of share of 10000 (ten times that of A). So, if B issues 100 shares at the price of 10\\$ its market cap will be 1000\\$.By comparing the market cap of A and B I'd say that the value of A is three times greater than B, however, that's not correct. Or I should say that it is indeed correct for what regards the market cap, but that's not the case if we consider the shares that have not been issued yet.So the question is, how can the market capitalization give a hint about the value of a company? Also, how can the market cap be used to compare companies without taking into account the ratio between outstanding shares and the total amount of shares? (like the example above)

Answer 1

Hey there,

There's a lot going on in the question, but I'm happy to provide my thoughts.

By definition, as you mentioned, market cap is equal to number of shares outstanding (shares available for trading) x share price.

That being said, that is not the only way to value a company.

For example, take the formula MV= D + E, where D is the market value of debt outstanding and E is the market value of the firm's equity.

Market Capitalization is more or less a quick, mental shortcut economists and analysts use to determine the size of the company.

However, a company may have significant assets on its balance sheet, that in no way is reflected in the number of shares outstanding; or share price.

So, you're wise for thinking that by comparing two different market caps, there is not enough to really determine the size of the companies.

Hope this helps.

-Jose