Financial Lessons and Investing Basics for Kids

How Much is a Company Worth?

Last night, out of the blue right as she was going to bed, my daughter (14) asked me what seemed like an odd question, "Do you know what the Starbucks boycott is about?"

"Starbucks? I don't think there is a boycott right now. If there is I haven't heard about it, and the stock seems fine." SBUX is a ticker on my daily watchlist, so I'm familiar enough with the stock to know if something big is happening.

"I saw something that said they lost $11 Billion because of a boycott. What is a boycott again?"

"Well, $11 Billion would be a lot of money. I feel like I'd have heard about that, but maybe not. I'll have to look it up. A boycott is sort of when a group of people get angry with a company because of something the company said or did, and they all group together to say they aren't going to buy anything from the company any more. So if there is a Starbucks boycott, it means they did something to make a group of people angry enough to make their own coffee or go to some other coffee shop. Anyway, I'll look it up tonight and see what it's all about."

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So she went to bed, and I went to the computer to bring up the SBUX chart. Nothing looked too out of place to me. The chart looked pretty typical. It had a couple of bad weeks, but zooming out it was easy to see that the drop was no different than a dozen other normal market pullbacks over the past couple of years. I also looked at their Earnings Numbers for the past couple of quarters and saw that they had about $3 Billion in revenue per quarter. Obviously they could not have lost $11 Billion. That would have been every dollar of revenue for the past year. Pretty sure those headlines would have raised alarm bells I would have heard, and that the stock price would have reacted to.

I then googled Starbucks boycott and got back a few stories about a Starbucks union saying something about Palestinians that was then attributed to the company itself instead of the union. I didn't dig into it too deep other than to see that the date of the incident would have been shortly after October 7th. Looking again at the stock price I could see that the stock was actually up since that point, not down.

I sent a message to my daughter with a link to an article about the controversy and I said:

SBUX stock is actually up since this started. SBUX has revenue of about $3 Billion per month, so it's basically impossible that they could have lost $11 Billion in two months. I doubt it's even cost them $100 Million.

I figured that would be the end of it, but in the morning she sent me a screenshot. She'd obviously kept digging on this herself.

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Ahhhh, there it was. Headlines were trying hard to make it sound as if the company had lost $11 Billion in actual earnings, when in fact what they were reporting was that the market cap had dropped $11 Billion. BIG BIG difference. 

An $11 Billion loss in earnings would be a huge hit. That would be actual money that was not spent at Starbucks, and presumably was spent at a competitor or on a competing product. 

Market Cap (Capitalization), on the other hand, is the total value of a company's outstanding shares of stock. It's calculated by multiplying the stock price by the total number of shares outstanding in the market. 

Starbucks has 1.5 Billion shares of stock, and a current stock price of $93, for a total market cap of $107 BILLION. In the past couple of years their stock has been as high as $126, and as low as $51. That means the market cap has been as high as $145 Billion, and as low as $58 Billion over that time. $11 Billion is a lot of money, but is a hiccup in the market cap of a company as big as Starbucks.

Market Cap = Number of Shares Outstanding x Stock Price

I was happy to see my daughter taking an interest in what was happening regarding Starbucks. It was a good opportunity to discuss the difference between a company losing money, and a company's market cap losing value. The two are not one and the same. In fact, if Starbucks lost $11 Billion in revenue because of a boycott, you can be sure the market cap would sustain a loss that was significantly more than that. 

Why is Market Cap Important?

Market cap is important because it allows us to understand the relative size of one company versus another. Two companies may have similar stock prices, but be vastly different in overall size. Let's look at an example:

We already know that SBUX has a market cap of $107 Billion, and a stock price of $93. 

Meanwhile, Apple's (AAPL) stock price is $187. That's almost exactly 2x higher than SBUX. Do you think that means that AAPL is worth 2x more than SBUX? 

No, in fact, Apple's market cap is $1.5 TRILLION. That's nearly 15x higher than SBUX. Apple is worth far more than SBUX. Stock price being a big or little number has little to do with the actual value (market cap) of a company. It's both the stock price and the number of shares that determine the market cap.

An easy way to think about it is with this example:

If two companies each had stock worth $10, but company A had 10 shares of stock outstanding and company B had 100 shares of stock outstanding, which would be more valuable?

Market cap of company A is $10 x 10 shares = $100.

Market cap of company B is $10 x 100 shares = $1,000

Same price stock, but company B is worth far more than A.

How the Stock Market Thinks of Market Cap

Now that we understand what market cap is we can start to understand how the market views companies at different levels of market cap.

  • Large-cap companies = Market Cap of $10 billion+  Large-cap companies are well established firms, dominant players in their industries, and often viewed as having less risk than small or mid-sized firms. 
  • Mid-cap companies =  Market Cap between $2 billion and $10 billion. Again, these are generally well established companies, and they are often viewed as having more room for growth. They tend to offer more growth potential than large-caps (but also more risk), and less risk than small-caps (but also less growth potential). 
  • Small-cap companies = Market cap between $300 million and $2 billion. Generally young companies. They may serve smaller markets, or it's possible their overall market hasn't been fully realized yet. These companies tend to be more aggressive and carry more risk than those above them. In exchange for the higher risk often comes the potential for higher reward.

Conclusion

In general, it's important to understand the concept of market cap so that we are able to differentiate between a company's stock price and how much a company is worth. It's market cap helps us compare its overall size to other, similar companies. In addition, it is helpful in order to be able to really understand what is being said when we see a headline saying, "Starbucks loses $11 Billion!" By understanding market cap we can look at that headline and constructively figure out the answer to, "But did they really?"

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