Q&A: Correlation between market capitalization of a company and its balance sheet / sales / profitability

Modified: 01-Jul-20

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Correlation between market capitalization of a company and its balance sheet / sales / profitability

Hello Dr. Malik

I have a specific query that I can’t seem to figure out by myself and would appreciate your help in sorting the issue:

What is the correlation between market capitalization of a company and its balance sheet/sales/profitability?

Specifically, if there are two companies (unrelated and perhaps in different sectors) with same market capitalization but different sales turnover/different profitability; does it have anything to do with the net worth or the book value or retained earnings/reserves or anything for that matter on the balance sheet?

My reason for asking is perhaps this could help find mispriced or undervalued securities in the markets while applying your principles for stock selection and evaluating between candidates for investments.

I hope I have tried to explain my question clearly and look forward to hearing from you.

Also I would like to take this opportunity to nudge you to please post more articles like you were doing before.

Thank you.

Regards

Author’s Response:

Hi,

Thanks for writing to me!

Your query is related to the presence of ratio of market capitalization (MCap) with balance sheet/sales/profitability and their usage.

Such ratios already exist and are in wide usage:

Market Capitalization to balance sheet ratio: the most common used ratio is price to book value, which is effectively market cap to net worth (current share price * number of share)/ (book value * number of shares)

Market Capitalization to sales ratio: this ratio is already widely used by investors by the same name.

Market Capitalization to profitability: the very famous price to earnings (P/E) ratio is derived from it: (current share price * no. of shares)/ (earnings per share * no. of shares).

These are parts of valuation analysis of stocks and you may read more about them in the following article:

How to do Valuation Analysis of a Stock

I am not able to devote much time to blog due to other personal and professional engagements which are taking a bit of time. I would write more articles whenever I get some time to spare.

All the best for your investing journey!

Regards,

Vijay

P.S.

 

DISCLAIMER

  • The above discussion is only for educational purpose to help the readers improve their stock analysis skills. It is not a buy/sell/hold recommendation for the discussed stocks.
  • I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013.
  • Currently, I do not own stocks of the companies mentioned above in my portfolio.

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