WHY A $5 STOCK CAN BE MORE EXPENSIVE THAN A $500 STOCK
A $500 stock isn't automatically expensive. A $5 stock isn't automatically cheap.
Imagine two companies.
COMPANY A
Stock price: $5
Shares outstanding:
10 billion
COMPANY B
Stock price: $500
Shares outstanding:
10 million
Which company is more expensive?
A quick look at the stock prices makes the answer seem obvious.
But it's completely misleading.
THE $5 COMPANY
Company A trades at:
$5 per share
But it has:
10 billion shares
So its market capitalization is:
$50 billion
That's the approximate value the stock market is assigning to the company's equity.
THE $500 COMPANY
Company B trades at:
$500 per share
But it has only:
10 million shares
So its market capitalization is:
$5 billion
The supposedly "expensive" $500 stock represents a company worth only one-tenth as much as the $5 stock in this example.
That's the first thing to understand:
Share price is the price of one piece.
Market capitalization is the value of the entire company.
THINK OF A PIZZA
Imagine two pizzas.
PIZZA A
Cut into:
100 slices
Each slice costs:
$5
Whole pizza:
$500
PIZZA B
Cut into:
10 slices
Each slice costs:
$50
Whole pizza:
$500
The individual slice price tells you almost nothing about the price of the entire pizza.
Stocks work similarly.
A company can divide its ownership into millions or billions of shares.
The price of one share depends partly on how many shares exist.
THIS IS WHY STOCK SPLITS CONFUSE PEOPLE
Suppose a company has:
100 million shares
at:
$100 each
Its market capitalization is:
$10 billion
Now the company performs a:
10-for-1 stock split.
Suddenly:
1 share → 10 shares
And the theoretical share price becomes:
$10
But there wasn't suddenly a 90% collapse in the company's value.
The company now has:
1 billion shares
at:
$10 each
That's still:
$10 billion
in market capitalization.
The SEC explains that stock splits adjust both the share count and stock price, without changing the company's market capitalization merely because of the split.
SO A $10 STOCK CAN ACTUALLY BE HUGE
This is why looking at the stock price alone can be dangerous.
Imagine:
Company X
$10 × 20 billion shares
=
$200 billion market cap
Meanwhile:
Company Y
$200 × 50 million shares
=
$10 billion market cap
Company Y's stock costs twenty times more per share.
But Company X is twenty times larger by market capitalization in this simplified example.
The $10 stock is the much larger company.
WHY DO COMPANIES HAVE SUCH DIFFERENT SHARE COUNTS?
Because companies don't all divide their ownership into the same number of pieces.
Shares can be created through:
Initial public offerings
Secondary offerings
Stock-based compensation
Acquisitions
Employee equity plans
Stock splits
Shares can also be reduced through:
Share buybacks
Cancellations
Reverse splits
So comparing two companies purely by their stock prices is like comparing two houses by the price of one square meter without knowing how large the houses are.
MARKET CAP IS THE FIRST NUMBER TO CHECK
If you want to know how large the market thinks a company is, start with:
Market capitalization
The basic calculation is:
Share price × shares outstanding
For example:
$5 × 10 billion shares
=
$50 billion
While:
$500 × 10 million shares
=
$5 billion
The price of one share is only one piece of the calculation.
BUT EVEN MARKET CAP ISN'T THE WHOLE STORY
This is where things get more interesting.
Suppose two companies both have:
$50 billion market caps.
They still might have very different amounts of:
Debt
Cash
Operating profit
Revenue
Free cash flow
Assets
A company with $20 billion of debt is financially different from one with $2 billion of debt, even if their market caps are identical.
That's why investors use other measures.
ENTERPRISE VALUE
Enterprise value tries to look at the value of the operating business while taking debt and cash into account.
A simplified version is:
Enterprise Value = Market Cap + Debt − Cash
Imagine:
Market cap: $50B
Debt: $20B
Cash: $5B
Enterprise value:
$65B
Another company might have:
Market cap: $50B
Debt: $2B
Cash: $15B
Enterprise value:
$37B
Same market capitalization.
Very different financial structure.
THIS IS WHY "CHEAP STOCK" CAN BE A DANGEROUS PHRASE
Someone might say:
"This stock is only $5. It has to be cheap."
Not necessarily.
A $5 stock could have:
20 billion shares
and a:
$100 billion market capitalization.
Another company could trade at:
$500
with:
10 million shares
and have a:
$5 billion market capitalization.
The $5 stock could represent a much larger company.
And being a larger company doesn't automatically mean its shares are expensive or cheap either.
You still need to compare the valuation with the company's:
Earnings
Revenue
Cash flow
Assets
Growth
Debt
Future expectations
THE SAME THING HAPPENS IN REVERSE
A $500 stock isn't automatically expensive.
Imagine a company has:
10 million shares
at:
$500
Market cap:
$5 billion
Now imagine it earns:
$1 billion per year.
That's very different from a $500 stock belonging to a company earning almost nothing.
The stock price by itself doesn't tell you the valuation relative to the business.
WHAT ABOUT A $0.50 STOCK?
The same logic applies.
A stock trading at:
$0.50
could sound incredibly cheap.
But if there are:
50 billion shares
outstanding:
$0.50 × 50B
=
$25 billion market cap
The stock isn't "cheap" simply because one share costs less than a coffee.
The company can have a huge valuation despite a tiny share price.
AND THEN THERE ARE REVERSE STOCK SPLITS
Companies sometimes do the opposite of a normal stock split.
Suppose a stock trades at:
$0.50
and the company performs a:
1-for-10 reverse split.
Ten old shares become one new share.
The theoretical price becomes:
$5
But shareholders don't automatically become ten times richer.
They now own one-tenth as many shares, each representing roughly ten times as much ownership per share.
The SEC notes that reverse splits reduce the number of shares while increasing the per-share price, but the company's overall market value does not automatically increase simply because of the split.
THE NUMBER OF SHARES IS PART OF THE STORY
When looking at a stock, ask:
How many shares exist?
Then ask:
Who owns them?
Then:
How much of the company is actually available for public trading?
This last point matters because not every outstanding share is necessarily freely available to public investors. S&P's methodology, for example, distinguishes total shares from the percentage available for public trading through the investable weight factor.
THE STOCK PRICE IS JUST ONE PIECE
Think of the information hierarchy like this:
$5 stock
↓
What does one share cost?
↓
Shares outstanding
↓
How many pieces exist?
↓
Market capitalization
↓
What is the market valuing the equity at?
↓
Debt + cash
↓
What does the company's financial structure look like?
↓
Revenue / earnings / cash flow
↓
What are you actually paying relative to the business?
That's much more useful than simply asking:
"Is the stock only $5?"
THE BIGGEST MISTAKE
The mistake is treating a stock like a product in a shop.
You see:
$5
and think:
Cheap.
You see:
$500
and think:
Expensive.
But a stock isn't a single product.
You're buying a fraction of a company.
And the size of that fraction depends on the total number of shares.
MAACAT PERSPECTIVE
A stock's price tells you what one share costs.
It doesn't tell you what the whole company costs.
That's why:
$5 × 10 billion shares = $50 billion
can be far more valuable than:
$500 × 10 million shares = $5 billion.
So the next time you see a stock trading at $3 and another at $300, don't immediately think:
"$3 is cheap and $300 is expensive."
First ask:
"How many shares are there?"
Because in the stock market, the price of the slice doesn't tell you the price of the pizza.
