Consider these stock prices –
- NTPC – Rs 88 per share
- Bajaj Auto – Rs 3000 per share
Do these prices tell you something if you were to decide which of these stocks to buy?
Well, people who look at a stock’s “price” and like the one that is in single or double digits, would consider NTPC to be cheaper than Bajaj Auto. But, in reality and sensibility, stock price is not the way you assess which stock is cheaper. You understand a business, arrive at its intrinsic value, and then compare that value with the stock’s price. If the price is lower than intrinsic value, it is a cheap stock. If the price is higher than intrinsic value, it is an expensive stock.
Anyways, now consider these two companies’ market capitalization (market cap = stock price * shares outstanding) –
- NTPC – Rs 85000 crore
- Bajaj Auto – Rs 85000 crore
Do these market caps tell you something if you were to decide which of these stocks to buy?
Not much, but they tell you something really important.
Market cap tells you what the whole company is worth as per the stock market. Of course, you also need to measure the debt and cash in the company’s books (to arrive at enterprise value, which is market cap + debt – cash), but market cap tells you roughly how much you must pay to buy the entire equity in a given company today.
Of course, looking at just market caps and assuming that whatever the market is charging for a company is what it’s worth, is also a mistake.
But one very important question that looking at market caps, say of the above two companies, lead me to is this – If I had Rs 85,000 crore to invest in a company and could be its sole owner, which of these two companies would I buy (assuming there are just these two companies I can choose from)?
Starting from this premise, my mind naturally will focus on basic business issues such as payback (how fast can the company generate Rs 85,000 crore in profit to return my investment), cash flow, debt levels, revenue growth prospects, capex needs, profit margins, and return on capital.
Generally, the longer it takes a company to return my investment, the more I am inclined to walk away.
And if I would not want to own the entire company, I will not buy 100 or even 10 shares of it.
“Own a business, don’t rent stocks,” is what Warren Buffett has often advised.
Thinking in terms of market caps and not stock prices is a way to have an owner’s mindset. And good investment behaviour starts with this attitude of ownership.
P.S. Consider one more example of the importance of thinking in market caps than stock prices. MRF’s stock price is Rs 65,000 per share (oh yes, per share!) while DLF’s stock price is “just” Rs 140. But you can buy the entire MRF stock at market cap of Rs 27,000 crore while you need to pay 33% more, or Rs 36,000 crore, to buy the entire stock of DLF.
That’s about it from me for today.