0

0

0

0

0

0

0

0

0

This article is more than 2 month old.

Explained: What market cap is and why it matters

Mini

Why should it matter if a company's market value attains a certain level? Can market value say anything about the ground reality of a market? The Buffet Indicator is often considered an important tool to find out whether the market valuation is in sync with economic reality.

Explained: What market cap is and why it matters
A popular way of knowing if a security is overvalued or undervalued is the price-to-earnings ratio. But when do you make that call for an entire market? One way of doing so is through the market value to gross domestic product ratio -- also known as the Buffett Indicator.
Named after billionaire investor Warren Buffett -- who once called it the best single measure to know where valuations are, the mcap-to-GDP ratio captures the comparison of a market's worth at any given time against the real economy it is sitting in.
The real picture 
The Buffet Indicator is considered by many an important tool to know whether the market valuation is in sync with economic reality.
For instance, BSE's market cap crossed the $3.5 trillion mark this week as benchmark indices broke a series of records, and currently stands at Rs 259 lakh crore ($3.52 trillion at $1 = Rs 73.5). With that milestone, some believed India became the fifth largest market the world over, behind the US, China, Japan, Hong Kong and the UK. However, it is difficult to get comparable data on a real-time basis for stock markets globally. India's real GDP was estimated at Rs 135.1 lakh crore in FY21.
Some say it is not applicable to all markets, especially ones with unique characteristics such as a large pie of informal economy.
So what is market capitalisation and what does it signify? Why should it matter when it reaches a certain level?
Essentially, it is the value of the company for its shareholders.
Here are some key points to know:
What it really is
Mcap is the number of outstanding equity shares times the market price of each share. Confused? It is an amount of money arrived at by multiplying the total equity shares of a company by its market price.
What it shows
The market cap of a company determines the economic value that it has created for its stakeholders. It also reflects what market participants think it is worth by estimating the earnings potential in the future. For a company, market value acts as an effective means to raise money as and when required in order to fund its growth plans. Usually, increasing market capitalisation is seen as an indicator of a company doing well fundamentally.
Is high mcap good?
Rising market capitalisation raises the chances of a company to make it to widely followed domestic as well as global indices. This in turn gives the company's shares more visibility, and, in the long run, also entices investor interest.
Market value vs enterprise value
Enterprise value is essentially the total value for holders of both equity and debt of a company. Unlike market cap, which only takes into account the value of all its shares at a given time, enterprise value gives a more holistic view by adding to the equity value the value of debt owed by the company.
When to go by enterprise value?
Most analysts use enterprise value relative to EBDITA to compare companies within a common industry. This helps them identify between undervalued and overvalued companies -- the same way the Buffett Indicator works for overall markets.
"Enterprise value is used to identify undervalued companies during bearish market phases by investors like me... Typically, for retail investors, market capitalisation, earnings growth and the price-to-earnings (P/E) ratio should be largely followed," said Sabharwal.
next story