What is a company's worth, and who determines its stock price?

A company's worth - its total value - is its market capitalization, and it is represented by the company's stock price. Market cap (as it is commonly referred to) is equal to the stock price multiplied by the number of shares outstanding.

For example, a stock with a $5 stock price and 10 million shares outstanding/trading is worth $50 million ($5 x 10 million). If we take this one step further, we can see that a company that has a $10 stock price and one million shares outstanding (market cap = $10 million) is worth less than a company with a $5 stock price and 10 million shares outstanding (market cap = $50 million). Thus, the stock price is a relative and proportional value of a company's worth and only represents percentage changes in market cap at any given point in time. Any percentage changes in a stock price will result in an equal percentage change in a company's value. This is the reason why investors are so concerned with stock prices and any changes that may occur since a $0.10 drop in a $5 stock can result in a $100,000 loss for shareholders with one million shares.

The next logical question is: Who sets stock prices and how are they calculated? In simple terms, the stock price of a company is calculated when a company goes public, an event called an initial public offering. This is when a company will pay an investment bank a lot of money to use very complex formulas and valuation techniques to derive a company's value by determining how many shares will be offered to the public and at what price. For example, a company whose value is estimated at $100 million may want to issue 10 million shares at $10 per share or they may want to issue 20 million at $5 a share.

(For more information on stocks and the factors that influence their prices, please see our tutorial Intro to Fundamental Analysis.)

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