Understanding the Discrepancy Between Stock Price and Market Capitalization
For some companies, the product of the number of outstanding shares and the stock price can differ from the market capitalization. This might seem puzzling, but several factors contribute to such discrepancies. In this article, we delve into the reasons behind this phenomenon and provide a detailed explanation through a real-world example.
Key Factors Contributing to Discrepancies
Dilutive Effect of Stock Options or Similar Management Compensation
A significant factor contributing to discrepancies is the dilutive effect of stock options and similar management compensation. When these options are issued, they represent a potential increase in the number of outstanding shares, even if the actual issuance has not yet occurred. The Treasury Stock Method is often used to estimate the impact of these options without changing the stock price. However, for simplicity, the diluted shares from most recent quarterly earnings are commonly used.
Recent Transactions and Market Activities
Recent transactions such as an equity offering, tender offer, or stock dividend can also cause discrepancies. These transactions involve the issuance of new shares or exchanges of existing shares for cash or other assets, thereby altering the number of outstanding shares and impacting the market capitalization.
Convertible Securities
Convertible securities, such as bonds that can be converted into a certain number of shares of stock if the specified stock price is met, can further complicate the relationship between the stock price and the market capitalization. These convertible securities serve as a form of debt that can be converted into equity, potentially increasing the number of shares outstanding.
Classes of Stock
The structure of the company’s stock classes can also explain discrepancies. For example, Berkshire Hathaway's Class A shares are significantly more expensive compared to its Class B shares, with the latter being worth 1/350th of the former. When calculating the market capitalization, it's necessary to account for the different values of each class and the number of shares outstanding for each. Other companies may have different stock class structures, where certain classes may not be tradable or may trade at different prices due to differing rights and voting powers.
Illustrative Example: The Case of Match Group
Let's look at a specific example to understand how these factors contribute to discrepancies. The Match Group is a company quoted in the Wall Street Journal, with a current stock price of $43.6323 per share and 63.23 million outstanding shares as of February 21, 2018. At first glance, the product of 43 and 63.23 million appears to fall short of the reported market capitalization of $11.5 billion.
The primary reason for this discrepancy is that the 63.23 million shares are not necessarily the total number of shares outstanding. These include shares held by investors and restricted shares held by management and employees. Not all shares are available for trading; some are retained by the company.
To find the total number of shares, you can refer to the company's quarterly reports or SEC filings. According to Match Group's full 2017 report, the total number of shares outstanding as of December 31, 2017, was 274.3 million. Multiplying this by the share price of $43 gives us the correct market capitalization of $11.5 billion.
Conclusion
The relationship between stock price and market capitalization can be complex due to various factors such as stock options, convertible securities, recent transactions, and the structure of different stock classes. Understanding these factors is crucial for investors and analysts to accurately assess a company's valuation and financial health.
By delving into the nuances of these factors, we can better grasp why the product of stock price and outstanding shares might not always align with the reported market capitalization, offering valuable insights for investment decision-making.