You Buy A Company When You Buy Stock Determine Market Cap, Compare Return On Investment

Imagine, just for fun, that you’ve just inherited $100 billion and you want to put all of it into the stock market. Which of these buying opportunities - each costing $100 billion based on recent stock prices - would you prefer: 1) all of Exxon, 2) all of Johnson & Johnson and Intel, 3) all of Microsoft, PepsiCo and Rubbermaid, or 4) all of Motorola, Ford, Bell Atlantic and United Healthcare?

No. 4, or No. 2 might be best, but the precise selection isn’t the point. The purpose of this little fantasy is to try to get you to think about investing in a new, simple, productive way.

Most people think of stocks as numbers that bob up and down in the newspaper tables, driven by changing popularity and prospects. Unfortunately, that’s a concept that promotes poor stock-picking.

There’s another way: “You should think of stocks as part ownership of a business.” That’s how Warren E. Buffett, the top investor of our era, recently paraphrased the number one idea he was taught by his mentor, the late Benjamin Graham.

The best way to think of part ownership is to think of whole ownership. The starting point for stock selection, then, is this question: What does the entire business cost?

Well, the cost of any business that’s publicly traded in the stock market is available every day, and it’s a cinch to compute: Just multiply the price per share by the number of shares.

The Boeing Co., for example, was trading a week ago at $77.75 per share, and there are 343 million shares of Boeing outstanding. To buy all those shares - that is, all of Boeing - would cost $27 billion.

Boeing’s $27 billion market capitalization, or market cap, is a good approximation of what the company is worth in the minds of investors right now.

To think of Boeing as being worth $77.75 a share is useless. To think of Boeing as being worth $27 billion in its entirety is the beginning of stock-picking wisdom - an holistic approach to investing.

The next stage is deciding whether $27 billion for all of Boeing is a good price. The most important consideration is Boeing’s operations. How much money is the company making? Because of a big write-off in the second quarter, 1995 earnings will be modest - only about $300 million. But over the past six years, Boeing’s profits have averaged about $1 billion annually. They hit $1.6 billion in 1991.

Are such earnings enough to justify a price of $27 billion? Clearly not. Merely putting $27 billion into high-rated tax-free municipal bonds at 5 percent would produce earnings of $1.4 billion a year. So, to buy Boeing at these prices means to bet that its profits will grow substantially as air travel grows, or methods of making airplanes become more efficient, or competition becomes less intense.

Is that a good bet? You’ll have to decide yourself, but, thanks to the market-cap concept, at least you’ll have an understandable framework for making a judgment.

Another reason market-cap thinking is useful is that it allows you to draw quick and dirty conclusions about relative value. In other words, you can easily compare Boeing’s market cap with that of other companies.

For example, the market is valuing all of Boeing at roughly the same price as all of financial powerhouse Citicorp ($27 billion) or drugmaker Eli Lilly & Co. ($28 billion).

Like most banks, Citicorp has had wildly erratic earnings (including outright losses) in the past, but 1994 profits were $3.3 billion and 1995’s will be around $3.0 billion. That’s an excellent return on a $27 billion investment. Lilly, meanwhile, has been churning out profits fairly regularly at a $1.2 billion-a-year pace.

Here’s another comparison: For the price of one-fourth of Netscape Communications Corp., which makes software for Internet browsing, you can buy all of Starbucks Corp., the coffeehouse chain. Starbucks, whose profits have risen with supreme consistency, is expected to earn about $40 million in the fiscal year ending September 1996. Meanwhile, a quarter-share of Netscape’s profits will come to about $3 million.

Finally, market-cap thinking instills patience. If you buy a stock as if it were a business rather than a disembodied number, then you’re likely to pay less attention to the ups and downs of its price in the market.