Confused about Market Cap

These are probably dumb questions but I'm confused.

  1. The news announced that Amazon hit a $1 trillion dollar valuation this year when its market cap hit $1 trillion but market cap is just shares outstanding x share price. Shouldn't this mean that it was valued at more than a $1 trillion at the time since some shares privately owned and were in treasury stock?

  2. Also, a massive share buyback would greatly decrease shares outstanding, so it would also greatly decrease market cap. So market cap is not what the firm is valued at because that would make no sense, right? Then why do people use market cap interchangeably with what a company is valued at?

Comments (7)

May 6, 2020 - 10:01pm
  1. Market cap is simply shares outstanding * share price. Treasury shares are no longer outstanding so they are not included.

  2. Theoretically, any share buybacks will reduce the supply on the open market. In theory, there should be an equivalent boost in the share price as a function of supply/demand that keeps the market cap the same. In reality, it does not always play out perfectly and there may be a change, but likely a marginal one.

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  • Intern in IB - Gen
May 6, 2020 - 10:11pm

Thanks, follow up question. Company A does an IPO and issues 100,000 out of 400,000 shares and the share price is $20. So then shares outstanding is 100,000 and market cap is $2 million.

  1. But the actual value of the firm is $8 million because only 1/4 is public?

  2. Then what's the point of saying Company A is valued at $2 million because you don't know what % is public?

Most Helpful
May 6, 2020 - 11:00pm

Not really. If they only issue 100,000 shares, they will be priced to meet demand for those shares. The market at this point views the equity value of the company is worth $2M, hence the $20 price. Now say the company floods the market with the remaining 300,000 shares, investors will still perceive the company to be worth $2M and will sell until the share price meets that. In these scenarios, the value of the firm is the independent variable, and the share price is dependent.

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May 7, 2020 - 12:00am

A buyback lowers value because cash leaves the company.

Separately, the announcement of a buyback may increase share price bc it has signaling value. It's a signal that the stock is undervalued. So, for that fundamental reason, it may increase stock price. But that's more indirect and may or may not happen.

May 9, 2020 - 5:22pm
Dr. Rahma Dikhinmahas:

A buyback lowers value because cash leaves the company.

I do not think the above is correct. Cash leaves the company but shares are reduced and therefore, EPS rises. BVPS could rise fall or stay the same. With that said, I would not view the company as being any more or less valuable, I agree that buy backs have a signaling value.

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May 7, 2020 - 1:18am

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