E Think Like A Buyer

When first learning about the stock market, a new investor naturally focuses on stock price. A share of Apple sells for $115, AT&T $33, Google $667, and Pandora Radio $21. A normal first reaction is that Google must be expensive and Pandora cheap. But it ain’t so.

The stock price reflects how the market—daily investor “auctioning” or buying and selling—values the stock. The stock’s market value (market capitalization or market cap) is number of shares outstanding times stock price, as with these four familiar companies:

MARKET VALUES

APPLE

AT&T

GOOGLE*

PANDORA RADIO

Stock Price

$115

$33

$650

$21

5.7 billion

6.15 billion

634 million

212 million

Market Value

$650 billion

$200 billion

$412 billion

$4 billion

Source: Yahoo! Finance
*This table averages the prices of Google’s two classes of stock and combines the shares outstanding.

Google’s stock price is over five times Apple’s, yet its market value is only two-thirds of the iEverything company’s. Pandora’s price is two-thirds of AT&T’s, but its market value is one-fiftieth! Stock price? Be gone with thee!

With stock price unceremoniously dispatched, we switch to thinking of a company as a business we are buying. A buyer examines all sorts of business factors and considers the value of the enterprise—the business—not the market value. Market value tells nothing about cash and debt, which are crucial to business health. A buyer will pay less for a business with more cash than debt, and in effect be paying more for another with more debt than cash.

Consider two lemonade stands with theoretically identical businesses. Joe’s stand is burdened by a loan to his parents (who are real sharks), but Jo owns her stand free and clear, along with a nice cash pile she’s put aside to get her through a cold summer. Would any of us pay the same for Joe’s as for Jo’s? Of course not.