Market capitalization or market cap represents the stock price of the company multiplied by the number of outstanding shares.
The stock price is therefore a relative and proportional value. It represents only percentage changes in the market cap at any given point in time. Any percentage change in a stock price will bring about an equal percentage change in the value of a company.
This is why investors feel worried about stock prices. Any adjustments that could arise as a decline in the stock of $0.10 will result in a loss of $100,000 for shareholders of one million shares.
How Share Price is Determined
When a stock is sold a buyer and seller exchange money for ownership of shares. The price the stock is bought for will become the current market price. By selling a second share, the price is the newest market price, and so on.
Quantitative techniques and formulas are used to predict the price of the shares in a company, namely discount models (DDMs).
They are based on the idea that the current price of a stock is equal to the sum of all its potential dividend payments if discounted back to its present value. Dividend discount models use the principle of the time value of capital (TVM) by calculating a company’s share by the cumulative total of its predicted future dividends.
How Market Cap Calculates
For example, Microsoft (MSFT) trades on a particular day for $71.41 and has 7.7 billion outstanding shares. Overall, the company is valued at $71.14 x 7.7 billion = $550 billion.
When you take this a step further, you will see that Facebook (FB) which has a stock price of $167.40. And then, the outstanding 2.37 billion shares (market cap = $396.7 billion) is worth less than a corporation with a stock price of $71.41 and an outstanding 7.7 billion shares (market cap = $550 billion).