You can measure the size of a company in several ways. Two important measures are market capitalization and total asset. “Market cap,” as it’s called, tells you something about the relative size of the company compared to that of other companies. Total assets indicate how much money the company has and how much money it has invested in the things that make more money. Taken together, these two measures help an investor judge whether the company’s common stock represents a good value.
The Types of Assets
Assets are things of value that help a company earn money. Tangible assets are ones you can see and touch, such as buildings, inventory and equipment. Intangible assets are ideas, such as patents and goodwill. Financial assets are a special form of intangible assets. These include accounts receivable and bond investments. Current assets are cash and items a company can turn into cash or expenses within one year, such as inventory, accounts receivable, supplies, prepaid rent and investments in Treasury bills. Long-term assets, also called fixed assets, include buildings, manufacturing facilities, land, equipment and most intangible assets.
Book Value vs. Market Value
Accounting rules don’t allow companies to increase the value of long-term assets beyond the price paid for them. For example, if a company bought a building 20 years ago for $10 million, its gross book value is still $10 million today, even if the company could sell the building for much more. Its net book value is substantially less than $10 million, because of the depreciation it has recorded over the 20-year period. Depreciation is the way a company expenses part of the purchase price each year for a set number of years. When depreciation is complete, the asset’s net book value equals its salvage value, which might bear little relationship to the asset’s current market value.
You calculate market cap by multiplying the current share price of common stock by the number of shares outstanding. The result is the current price investors assign to the company. Investors look beyond the book values of assets to decide how much to pay for stock shares. This calculation requires investors to value assets at their current values and to subtract the company’s liabilities -- the money it owes to others. Other factors affecting market cap include the company’s earnings, growth rate and common stock dividends. A company’s market cap isn't the same as its market value, which is the price someone would pay to buy the entire company.
Value Investing vs. Growth Investing
“Value investing” is the practice of buying stock in companies that have a market cap lower than the market value or book value of “net assets” -- that is, total assets minus total liabilities. The thinking is that value investments are bargains, because the stock price understates the value of the company. Therefore, even if the company fails, the parts can be sold off for more than the market cap. “Growth investing” looks at the earnings growth of the company to price the common stock shares. Growth investors aren't as concerned with asset values -- book or market -- as much as they are with the amount of income the assets can produce. Demand for the company’s stock by growth investors can cause the market cap to exceed the market value of the company’s net assets.
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