How Can Investors Use Market Cap as an Evaluation Metric?

Market capitalization, or market cap for short, is a metric that's defined as the number of shares outstanding for a company multiplied by its share price. This measure can be used to compare companies in the same industry. On a Fool Live episode recorded on April 14, Fool contributors Brian Stoffel, Brian Feroldi, and Brian Withers answer a viewer's question about how to use the market cap metric to think about the future potential of a stock.

Brian Stoffel: I've got one here from [viewer] FI Father, said, "Can you expand on how you use market cap is evaluation metric, is it a matter of bigger being better, or is there a sweet spot that you like?"

Yeah, basically, what you need to do is spend some time in an industry to get an idea for how big companies can get. When Netflix (NFLX -0.62%) made the pivot to becoming a streaming company and having their own content, then valuing them on par with where a Blockbuster might have been 10 years earlier didn't make sense anymore because they were making their own content. You went from saying, Netflix could be maybe this big to saying, there's Disney sitting at this market cap and here's Netflix way down here. I could see how could grow into that. With Lemonade (LMND -1.93%), what I'm talking about is a five billion-dollar company, which on the public markets is considered small to mid cap. But you can look at some of the larger insurers and see that they are much more valuable. Then you can say, ''Okay, I can see how Lemonade could grow into a much bigger valuation." Again, the reason I chose market cap is because Brian Feroldi said, it's a really difficult company to understand what their growth trajectory could be like.

Brian Withers: Yeah, and market caps like you're saying, they vary quite a bit. I remember when I first looked at Netflix and was thinking about them as the Blockbuster replacement. Blockbuster, the largest it ever got was like six billion dollars. Netflix has far away eclipsed that today. Certainly comparisons to Disney and other content studios, as well as streaming services. It's in a category of its own now.

Brian Feroldi: If you went back in time and said, if you compare the market cap of Amazon to Walmart and said, well, that's the limit.

Withers: Yeah.

Feroldi: You were wrong by 5X and counting. But I think that looking at that is tremendously helpful. Just realizing that it's not a one-for-one thing. Lemonade is a five-billion-dollar company, I looked up like Progressive insurance. I realized it's not a one-to-one competitor, but that's a $55 billion company, for example. Do you think Lemonade could be as successful as Progressive is? With obviously an entirely different business model. Is it out of the question to think that Lemonade if it's super successful, could be as big as Progressive is today?

If you think the answer there is yes, then it could 10x from today, for example. My favorite is when I find a company that meets all of my criteria and it's tiny. If it's under $500 million, for example, you're like, wow, this thing could 10x and still be smaller than Lemonade is today. Like that's my favorite.

Withers: Yeah, those are harder and certainly riskier to call whether they would make that leap or not.

Feroldi: We had a question here about Coinbase (COIN -2.31%), for example. If we're going to talk about that. So Coinbase just came public today and if Yahoo! is correct, which I don't think it is, but I think it's roughly correct. The market cap today is $86 billion.

Stoffel: Wow.

Feroldi: Yeah. What what do you compare that to. Well Charles Schwab is $127 [billion]. It's basically today as big as Charles Schwab is. Is that a one-for-one comparison? I don't know. I mean, in theory, Coinbase could add customers globally, right? Is Charles Schwab more restricted? Well, I don't know.

Stoffel: I think Intercontinental Exchange, which owns a ton of global markets, including the New York Stock Exchange, is just $66 billion.

Feroldi: Yes. Coinbase is bigger than the.

Stoffel: Intercontinental.

Feroldi: Than the NYSE. How about Nasdaq? How big is Nasdaq? I don't think Nasdaq is like $20 billion, $25 billion, yeah. Coinbase is the size of the Nasdaq and the NYSE. The companies, not all the companies on those exchanges, but the companies themselves.

Needless to say, it's big. It's really big. Can you see Coinbase becoming a trillion-dollar company?

Stoffel: That's a great way of using market cap.

Feroldi: Yeah. For Coinbase to 10x from today it would have to be a trillion-dollar company. Can that happen? I don't know. Maybe.

Withers: Maybe. Yeah.