This is the first episode of Investing for newbies. Here we talk about what is market capitalisation and why it’s what you should consider why buying a stock.
Transcript of video
If I told you can buy this apple in my right hand for £1 and this one, in my left hand, for £2. Most rational people would pick the one in my right hand, the cheaper one.
But… it’s not as easy to pick stocks in the stock markets. In fact, it’s super complicated and so most people just stay away.
Let’s start with a simple example. Imagine there are two completely identical companies like these apples here.
Company A trades for £15 per share and Company B trades at £30 per share. Same management, same product. Everything is the same. Which one would you choose?
Well, of course most average people would choose Company A at £15 per share because it’s the cheaper one.
The problem though is that £15 is not for the whole apple or the whole company, but in fact, for just one piece or one share in the company.
Companies can smartly decide the size of each share that they issue in various ways but we won’t go into that right now. What we do know is Company A gives us a very small piece of the apple and company B gives us a piece which is at least 3 times the size. Which would you choose now?
Obviously Company B because it’s better value.
The key point here is it’s not enough just to know the price of the share, we should also know how many shares have been made or how many pieces have actually been cut.
Once you know the price of each piece and the total number of pieces, you can figure out the price of the whole apple. Remember these two companies, or apples, are identical, and what we now know is Company A is available at £150 and Company B is available at £90. So which one is better value? Company B of course. Now let’s take a moment to fix the terminology. All this time we’ve been talking about price per piece which actually means price per share. And number of pieces is, obviously, number of shares. And when you multiply the two together, you get the total price of the whole company. And this is something called market capitalisation.
Let’s look at a real world example. Tesla trades at $228 per share, which seems more expensive than Apple and Netflix, but, if you compare their market capitalisation, you’ll see that Tesla is actually the cheapest at 34Bn$.
So the number of shares does matter.
Next time you are researching stocks, remember to consider the price per share and the number of shares which when you put them together gives you market capitalisation.
In the real world, there are no identical companies, they are all different. And in order to compare them, as well as market capitalisation, what you need to be able to do is look at the juice. This we’ll discuss in the next episode.
For now, I’m going to help myself. See you next time.