3.5.1. Market Capitalization, Equity Value, and Related Multiples
A company’s market capitalization, or market cap, is the total market value of the company’s equity, determined by multiplying the market price per share and the total number of shares outstanding:
market capitalization = market price per share x shares outstanding
Market cap is not a perfect measure of value, first, because a company’s stock price can be affected by external market forces that have little to do with the worth of the company, and second, because it does not include debt and other items that are included in more comprehensive metrics like enterprise value (introduced in the next section). Because of the shortcomings of market cap as a pure valuation metric, it is more often used to band companies together by size for purposes of comparative analysis. This is discussed in Appendix A.
Example: A company has 100 million shares outstanding. The current market price is $20 per share. The company’s market cap is $2 billion (100 million x $20).
Equity value is often used as a synonym for market capitalization, but it has a more precise meaning. You can think of equity value as a specific way of assessing market cap. Equity value excludes preferred stock and includes the value of in-the-money stock options, warrants, and convertible securities. Fortunately, we already learned how to make this adjustment: the treasury stock method, which converts common shares outstanding into fully diluted shares outstanding. The formula for equity value is:
equity value = market price per common share x fully diluted shares outstanding
Recall that fully diluted shares outstanding is specifically a count of common shares that would be outstanding given certain assumptions. This means that equity value is also a measurement specifically of the value of common stock. This is deliberate. When it comes to valuation, preferred stock is thought of as being too di