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Let's say for example, the refrigerator market is sized at 10 million dollars (hypothetical example), if the market cap of a company is, say, 20 million, is it worth investing in the stock? Can it ever happen that a company's market cap exceeds the total market size (or say addressable market size)?

30

The difference between the two numbers is that the market size of a particular product is expressed as an annual number ($10 million per year, in your example). The market cap of a stock, on the other hand, is a long-term valuation of the company.

  • 3
    Good point, there is nothing magical about a year. The market size is also $200.000/week. Both rates are not comparable with an absolute number. – MSalters Jun 9 '16 at 9:47
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    Unit commensurability or dimensional homogeneity is the technical term for the phenomenon seen here. – Damian Yerrick Jun 9 '16 at 16:33
  • @DamianYerrick - I love Dimensional Analysis more than most, but in this case, the variables flow. At least in theory. Market cap is discussed in terms of P/E, and the E is annual. The E can only be a fraction of sales, and sales, some fraction of the market. The market, of course, is a moving target. – JTP - Apologise to Monica Jun 10 '16 at 10:18
  • @JoeTaxpayer I believe that market capitalization is simply the total market value of the company: Price per share * Number of outstanding shares. No annual numbers there, and Earnings doesn't come into it at all. – Ben Miller - Reinstate Monica Jun 10 '16 at 11:53
  • @JoeTaxpayer Market cap is in dollars, and share price (market cap divided by shares outstanding) is in dollars per share. Revenue and earnings are rates of money flow in dollars per year, and EPS is in dollars per share year. So P/E (market cap divided by earnings, or equivalently share price divided by EPS) is in years. The question is about market cap vs. revenue. – Damian Yerrick Jun 14 '16 at 23:46
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First read mhoran's answer, Then this -

If the company sold nothing but refrigerators, and had 40% market share, that's $4M/yr in sales. If they have a 30% profit margin, $1.2M in profit each year. A P/E of 10 would give a stock value totaling $12M, more than the market size. The numbers are related, of course, but one isn't the maximum of the other.

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    And sooner or later something will happen to reduce the margins even if the company is called apple! But if the market is still growing... – Ian Jun 9 '16 at 13:15
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If you are calculating:

  • the market size as the annual sales of all refrigerators at $10 million;
  • and the market cap as the value of Company A's shares times the number of shares being equal to $20 million;

keep in mind that company A probably also sells washers, dryers, stoves, dish washers.... Each of which has their own market size.

Also remember that people pay X times the value of earnings per share, so the value depends not on sales but on earnings, and expected growth.

  • I think it's implicit in the question that the company only makes refrigerators. (Or, if you prefer, that "refrigerators" is a proxy for all the products the company makes.) – David Richerby Jun 10 '16 at 9:02
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The quickest way to approach this question is to first understand that it compares flows vs. levels.

Market size is usually stated as an annual or other period figure, e.g. "The market size of refrigerators will be $10mn in 2019." This is a flow figure.

Market capitalization is a level figure at any given point in time, e.g. "The market cap of the company was $20 million at the end of its last fiscal quarter."

Confusion sometimes occurs when levels and flows are used loosely for comparisons. It is common for media to make statements such as "Joe Billionaire is worth more than the GDP of Roselandia." That is comparing a current level (net worth) with an annual flow (GDP).

With this in mind, there are a variety of conditions where a company's equity market value will exceed its market size. The most extreme example is an innovating, development-stage enterprise, say, a biotech company, developing a new market for a new product; the current market size may be nil while the enterprise is worth something greater.

The primary reason however for situations where a company's equity market cap is greater than its market size is usually that the financial market expects the enterprise (and oftentimes its market, though this isn't necessary) to grow substantially over time and hence the discounted value of the company may be greater than the current or near future market size.

A final example: US annual GDP (which comprises of much more than corporate incomes and profits) for 2014 was about $17.4tn while the nation's total equity market value in 2014 was $25.1tn, both according to the World Bank. That latter figure also doesn't include the trillions of corporate debts these companies have issued so the total market cap of US, Inc. is substantially greater than $25.1tn.

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It is ALWAYS possible for a company's valuation in the market to be larger than the market it serves, and in fact it is not uncommon. There's valid argument that Uber would be a good example of this, with a market cap of more than $60 billion. Market cap is the total value of all shares outstanding. Keep in mind that what a company's shares trade for is less a reflection of its past (or, to some degree, even present) revenue activity and more of a speculative bet on what the company will do in the future.

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    What is the current value of the transportation market? – JTP - Apologise to Monica Jun 9 '16 at 0:31
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    @JoeTaxpayer: well, the question's example is the "refrigerator market", so the relevant "market" for Uber would presumably be taxis rather than transportation. You could also throw in local delivery. Although if I can Uber a plane that's cool: other companies do this but who wants the hassle of installing a separate app for it? Anyway, quora.com/… – Steve Jessop Jun 9 '16 at 10:05
  • Boy, asking about the size of the transportation market is like asking how many gallons of rain will fall on the planet today! (grin) Seriously though, one would have to narrow it down to the "mode" of transportation (taxis, airlines, local bus, long-haul bus, etc.) and then pick a region (whether it's a city, state, country or continent). That's just the first bit. The point is, this would be difficult for many reasons I can't cover here. It isn't a bad question, though. – Daniel Anderson Jun 9 '16 at 13:46
  • Steve set me straight. Clearly, I picked the wrong word. I am old and lost the word taxi for a bit. Now that I have taxi back, I'll need to look at my wife's drivers license to recall her name... – JTP - Apologise to Monica Jun 9 '16 at 16:03
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A company's valuation includes its assets, in addition to projected earnings. Aside from the obvious issue that "projected earnings" can be wildly inaccurate or speculative (as in the case of startups and fast-moving industries like technology), a company's assets are not necessarily tied to the market the company is in.

For the sake of illustration, say the government were to ban fast food tomorrow, and the market for that were to go all the way to zero. McDonald's would still have almost 30 billion dollars worth of real estate holdings that would surely make the company worth something, even though it would have to stop selling its products.

Similarly, Apple is sitting on approximately $200 billion dollars in cash and securities in overseas subsidiaries. Even if they never make another cent selling iPhones and such, the company is still worth a lot because of those holdings.

"Corporate raiders" back in the 70's and 80's made massive personal fortunes exploiting this disconnect in undervalued companies that had more assets than their market cap, by getting enough ownership to liquidate the company's assets. Oliver Stone even made a movie about the phenomenon.

So yes, it's certainly possible for a company to be worth more than the size of the market for its products.

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You are comparing two things that are not comparable.

The "market size" would be the total annual revenue in one market, in this year.

The "market cap” of a company is the number of shares multiplied by the share price. This should be equal to the total profit that the company is going to make through its life time, taking into account that you would get interest on an investment, so future profits have to be counted less accordingly.

So if the "market size" is ten million dollars, and a company has four million revenue in that market with one million profit, and everyone thinks that company will continue making that profit for the next fifty years, then surely one million a year for the next 50 years is worth more than ten million.

That's if the market stands still. If the "market size" is ten million, and we expect that market size to double for the next three years, then the market size is still ten million, but a company having a 40% share of a market growing at that speed is going to be worth a lot more!

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