Sometimes, we want to know what a company is worth, even if it's not public or hasn't been public long, which is where implied market cap comes into play. This calculation can help you value an IPO, merger, or other major change to a company before you invest in it. Read on to learn more.
What is the implied market cap?
The implied market cap of a company is an estimation of what the market capitalization should be if particular assumptions come to pass. It's often used when the company doesn't have any shares issued yet, like with an initial public offering (IPO), or when something about the company is about to fundamentally change, such as with a pending merger.
The implied market cap is not meant to be a guarantee of future performance, since no one can really guarantee that. It's more of a way to analyze how the company could be valued if a particular event were to take place. For example, if a company launched an IPO with 100 million shares at $10 each, or if new shares were to be issued.
How to calculate the implied market cap
The implied market cap is very easy to calculate using the most basic methodology. Simply determine the average closing price for the period you want to look at, like a certain number of days after an IPO, or the issuance price on IPO day, and the number of fully diluted shares outstanding.
The formula looks like this:
Implied Market Cap = Estimated Price Per Share x Number of Fully Diluted Shares Outstanding
So, if, as in the above example, your company had 100 million shares, planning to IPO at $10 each, it would look like this:
Implied Market Cap = $10 x 100,000,000
Implied Market Cap = $1,000,000,000
You can also do this calculation using a period of time, like the first two weeks after the IPO. In that case, just replace the price per share with the average of all the closing share prices for those days.
So, if the average closing price across 14 days was $15, then it would be $15 x 100 million, which is $1.5 billion.
Pros and cons of using implied market cap
Using implied market cap is essentially using an estimate to guess what the future may bring. This can be good and bad, but it helps provide some kind of framework for understanding the value of a company that may not have one yet.
On the other hand, without careful planning and calculation, an implied market cap can literally be anything you want it to be, and it is easy to accidentally create a valuation that you'd like, rather than one that is realistic. For example, if I make assumptions about a merger for a company I'm really bullish about, I might grossly overestimate its implied market cap, and then be deeply disappointed (or financially damaged) by my enthusiasm.
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Why does implied market cap matter to investors?
The implied market cap is really important to investors who are interested in IPOs or who want to deal in companies that are going through major changes. This analysis, when performed properly and without bias, can help you plan your investment in the new company in a much safer way.
Using implied market cap, especially when it's coming from a number of sources you trust, can tell you if you want to invest, how much to invest, and how the stock will fit into your portfolio. It can also help you decide if you want to exit an investment if a major change is coming, like a merger or acquisition.
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