Fundamental Stock Screening

Point in Time Backtesting

You will often hear the phrase “Market Cap” used in the financial space, but you may not know what it means, how it’s calculated, or the implications/biases it cultivates.

Let’s dive into what it is, an analogy of its value, and how it applies to businesses in real-time. It’s time for you to capitalize by understanding market capitalization!

What is Market Cap?

What is market cap? Market cap, or market capitalization, is the total value in dollars of a company’s outstanding shares in the stock market. 

As you read the words, you may have an idea of what Market cap is, but the cold-cut definition is important.

It is essentially how much the company is worth on the stock market. 

How is it divided? Market cap is divided into micro-cap ($50-$300 million), small-cap ($300 million to $2 billion), mid-cap ($2 billion to $10 billion), and ​​large-cap ($10 billion or more).

Why is the market cap valuable? The division allows you to compare the financial health of a company against other companies of the same size.

Market Cap Analogy 

Now we are going to walk you through an analogy, to hopefully help you understand Market Cap a little better. Jennifer’s has made a come-back with her lemonade stand. Ben Graham is evaluating if it’s worth the investment. He begins by calculating the stand’s market capitalization. 

Jennifer’s lemonade sells for $1.50 per cup, and you sell an average of 15 cups per day, so the daily revenue is $22.50, meaning the weekly revenue is around $112.50.

There are 100 shares of the company and Jennifer plans to sell some. If each share is sold at $10, then all the shares are worth $1000. The market capitalization is the same price as the total value of the stand’s outstanding shares, which is $1,000. 

Once Ben Graham learns the market cap, he takes that and compares it to three other local businesses on the same street. 

  • Betty’s Bakery: MC = $18,000
  • Sally’s Soda Shop: MC = $7,000
  • Jennifer’s Stand: MC = $1,000
  • Louis’ Lemonade: MC = $800

Graham looks at the four local businesses on the same street. Betty’s Bakery appears to be the safest because of its larger size. Sally’s Soda is the highest in the drink market, Jennifer’s Stand is the stronger of the lemonade stands, and Louis’ Lemonade should be put aside as a potential option. Graham decided to put off Louis and Jennifer because they were too small. He does not invest in Betty’s Bakery because of its minimal potential for growth. He finally settles on Sally’s Soda Shop because of financial health, potential for growth, and he really likes Coca-Cola. 

Real-Life Example of Market Cap 

Abercrombie & Fitch (ANF) has been going up due to recent AI inclusion, and their figures have consistently moved upward. 

The following is the data recorded for ANF on September 12th, 2023.

Financial MetricsANF
Closing Price52.26
52-Week Range 14.43 — 55.52
Market Cap 2.707b
Volume / Avg. 30 days 1.662m / 2.097m
P/E24.7
Dividend / Yield 0 / 5.8 per 1,000
EPS T12M2.2
Piotroski F-Score T12M 8
Beta 1.101
Green Flags High F-Score
Red Flags None

What does the market cap indicate? ANF is valued at $2.707b, putting it in the mid-cap category,. This means it is a medium sized company. When a company is this size, it can potentially pull itself out of financial difficulties based on its resources. Since it is still mid-cap, the company has less room to grow. It could still grow to the point of being a large cap, but that’s easier said than done.

Here are some other questions you could ask about the company:

  • Why is the market cap at that size?
  • What is the probability of growth? 
  • Is the company financially stable?

Takeaways 

With another financial metric under your belt, you’re on your way to analyzing companies and finding success. Market cap gives you a glimpse into a company’s size, health, and potential growth, on top of giving you a baseline for comparing it to similar or competing investment opportunities.

Keep up with Equities Lab’s content and launch yourself into a profitable investment journey. Happy investing!