The Implied Meaning of a Market Cap

Apple is worth $2,000,000,000,000. That is a lot of money” said Anthony Pompliano on Twitter the other day. Dave Collum promptly corrected him: “priced at.” This is a very important and warranted distinction. We talk about the market capitalizations of companies all the time, but less often we think about what it actually implies. 

For Every Buyer there is a Seller

The current price of a publicly traded stock is the most recent point where the most willing seller and most eager buyer matched. So when Apple stocks ended a trading day at $498, the last buyer and seller that were matched were willing to do business for that price. For someone to buy, someone also has to sell. 

But the market price only gives us some information about the marginal sellers and buyers. One an average day, somewhere between 100 to 200 million shares of Apple stock will change hands. That’s a lot of shares. On particularly busy days, this will exceed 300 million. On a slow day, however, as little as 50 million shares will change hands. But Apple has 4.35 billion shares outstanding. So, even on the most hectic days, less than 7% of the outstanding shares will change hands.

The 7% figures is likely deceptive as high frequency trading and other forms of day trading and market making might overstate the fact that the majority of stockholders will not sell on a given day. 

Therefore, the market cap and stock price of a company will tell you where it is priced at by the market. it won’t tell you where the stock is valued at by the market.

What is Inflation Anyway?

I feel like we have made inflation deceptively simple. We have this exact number for it. The Bureau of Statistics will declare something like “last month, the inflation was 2.46%, annually adjusted.” It will do so with an number that is so precise that at will have at least two decimals, implying the surgical accuracy employed to get to that particular number.

We don’t seem to ask ourselves how we come up with these number, do we?

Do We Even Know What Inflation Is?

The great Milton Friedman did not have even a shadow of a doubt: “Inflation is always and everywhere a monetary phenomenon.” Well, here is what the equally great Robert Solow said about Milton Friedman: “Another difference between Milton [Friedman] and myself is that everything reminds Milton of the money supply. Well, everything reminds me of sex, but I keep it out of my papers.”

In Japan they have been expanding the money supply for decades. They can’t seem to produce inflation, no matter how hard they try. If we ask the European Central Bank what inflation is, they say something like “inflation occurs when there is a general rise in prices.” (They will also ask if you have seen the inflation monster and offer you to watch a cartoon about price stability).

If inflation is just general rise in prices, then why do prices rise or fall? Most would say, because changes in supply and demand. Don’t prices of products and services tend to drop over time? How do we even measure this?

How to Measure Inflation?

This seams to me an exceptionally tricky undertaking. If inflation is supposed to measure changes in the price of the stuff we buy over a period of time, what happens when we start buying different stuff over time? Our behaviors and preferences are constantly changing? Imagine a lab scientist that has to test his experiment on rats one day and then repeat the experiments with hamsters.

Do you see the problem here? The stuff we buy is not constant. Take mobile phones for example. How can you realistically measure the inflation in mobile phones from one year to another? Or even, how do you compare the price inflation of mobile phones to a period 20 years ago, when there were no mobile phones?

What about all the stuff we don’t pay for yet derive some benefit from? How do you factor in the change in cost of consuming Google searches into any inflation measurement? Should you measure the increase and decrease in paid ads displayed with organic searches? 

And there there are substitute products. If pork rises in value, relative to beef, you might be inclined to consume more beef and less pork. But the baskets of goods and services will take that into account.

So next time, when you see an inflation number with a couple of decimal points. Ask yourself how it was measured and how accurate that measurement could be.