A intrigued Friend asked me today what is the first thing I looked at when it comes to researching and understanding a stock. Without doubt I look at Market Capitalisation. Many will question why so here are my answers:
The size of the company is a bloody big factor in determining whether the shares suit me. Typically, if the stock is a large cap, it tends to have more stable revenue streams and less volatility in the market place.
Mid and Small cap companies meanwhile have more fluctuations in their stock price and earnings typically down to only serving single areas of the market.
Why is that important to me?
I quite like a little volatility. Reason being, I invest in both short and long term. I have stocks in my portfolio I plan on keeping for decades (I hope) and there are certain stocks I am keeping my eye on, potentially looking to sell and take my earnings within the next 6 months to 2 years.
If the stock in question is a small to medium cap company £150 million to £1 billion I would look at the fluctuations and trends to purchase it on the cheap or on a drop for that week/month, and not invest as much as I would with Large Cap Stocks with an intention to take earnings and walk.
Whereas with the larger caps, I would look at the fluctuations and troughs with more caution and get to the root cause as to why. The large caps I would want to keep for a longer amount of time than the mid to small typically.
Thats really a side point. The golden gem in the market cap is when you compare it to full year profit.
Let’s look at Beazley PLC vs Hiscox:
£1822.8m market cap.
Full Year PBIT £184.1m.
Thus Market Cap is 9.9x PBIT
£2762.9m market cap.
Full Year PBIT £231.1m.
Thus Market Cap is 12x PBIT
This ratio determines how cheap to stock is comparatively to another. In this case, Beazleys profit against size of the company shows more value for money compared to Hiscox. This is just the first factor I look at when analysing stocks against each other. Not a be all and end all.
And that is why Market Capitalisation is the first analysis I look at when interested in stock comparisons.
The Young Investor