Why market cap is dumb

Why market cap is dumb – Kristina Chodorow's BlogSkip to content

When I was a kid, I went to a tag sale “for kids, by kids” where kids sold their junk/toys to other kids. I was wandering around and saw a shoebox filled to the brim with marbles. I went over and there was a sign on the box that said, “25 cents/marble”.

“How much for the whole box?” I asked the kid.

He thought for a second. He was around my age, maybe a little older. “$5,” he said.

“Sold!” I said quickly, handed him $5, and ran off with my hundreds and hundreds of marbles before he realized how deep a discount he had just given me.

Suppose there were 300 marbles in the box. The box “should have” cost 300*25 cents=$75. Obviously no one is going to pay $75 for a box of marbles, which brings us to the basic problem with market cap and the stock market.

The market cap of a company is basically the number of shares it has issued multiplied by price per share. However, if we think of a share as a marble, the market cap is that ridiculously inflated $75.

How much of this stock are people actually trading? Google, for example, has 723,000,000,000(ish) shares outstanding. Daily trading volume is around 1,500,000. That is .0002% of the outstanding shares. Translating that into marbles… that’s a lot less than one marble.

But let’s say a couple of people buy individual marbles, and then start trading them between themselves for 25 cents. Someone who hasn’t seen the kid’s booth offers a buyer 30 cents for a marble. Doing some quick math, people realize that marble boy’s net worth has gone from $75 to $90. “Hey, that kid just made $15. We should tax him on that.”

And that’s why a wealth tax is stupid.