Market capitalization (market cap) is defined as stock price times shares outstanding.

To explore market cap, let’s use an example. Suppose that your team wants to expand the asset base by $40 million.

You begin by answering the question, “What is our financial structure?” You decide upon a Leverage () of 2.0, or 50% debt 50% equity. Therefore, you need $20 million in new equity.

When you look at your projected earnings, you believe you can retain $5 million in profits. It follows you must raise $15 million from the sale of new stock. If the stock price is $30, you must issue $15M/30 = 200 thousand shares.

The implications for other performance measures include:

• Stock price: With more shares outstanding, it will be more difficult to grow EPS and dividends. Therefore stock price will grow more slowly.
• Market share: Depends on the type of investment. Since you can match new debt with the new equity, you can grow the asset base quickly. If used to expand the product line, the company gets bigger faster than if you use retained earnings alone. However, if the company investments are intended to reduce costs (probably via automation) , then market share will stay flat or even fall.
• ROS: Also depends upon the type of investment. Product line expansions tend to hold ROS constant. Productivity improvements improve ROS.
• Asset turnover: Likely falls somewhat. The asset base grows, but depending on the type of investment, sales could stay flat. Either way, there are more assets.
• ROA: Can grow, but because of the larger asset base, will grow slowly at best and could fall.
• ROE: Can grow, but will grow slowly at best.
• Cumulative profits: Grows. The larger asset base produces wealth, but producing it efficiently is not a concern.