1️⃣ Market Capitalization — the absolute price that matters
Many investors incorrectly believe that a stock price tells you how expensive a company is.
When a company “goes public,” the owners are basically saying: We’re selling slices of our pizza...who wants to buy some? The original owners cash out, letting strangers — like you and me — buy in.
Some big, amazing companies never go public. Some tiny, terrible ones do. But in both instances the original owners take some chips off the table.
When you open your phone's stock app and see:
Meta: $769/share
Google: $202/share
…it actually tells you nothing useful.
A $769 stock isn’t “more expensive” than a $202 stock. A pizza’s cost doesn’t change just because the slices are cut bigger.
You need to know how many slices exist. Multiply:
That’s the real price tag — what the market says the whole company is worth.
Apple: $229/share × 14.84B shares = $3.4 trillion market cap
Elf Beauty: $101/share × 56M shares ≈ $5.7 billion market cap
For $3.4T, you could be the sole owner of Apple (caveat emptor: taxes in California stinkkk).
And Apple's market cap is ~ 600x bigger than Elf Beauty (sorry, Hailey Bieber). That’s why $1,000 buys you the ownership of:
0.0000000294% of Apple
0.0000176% of Elf
If you can engineer your brain to think in terms of market cap (and the % ownership of that market cap you would get for your investment), your decisions around buying/selling stocks will instantly be more informed.
To take a step further (...and I'm dramatically simplifying here), you might consider that the market is telling us that some trendy, boutique beauty company is 600x less important than Apple. Or that for every $100 people spend on Elf products, they spend $6,000 on Apple products.
And you, as an owner of Elf, can own 600x more of the company (%) for the same $1,000 investment. 600x more claim to their profits and success. Our human brains struggle with magnitude, but at the very least that should feel directionally correct to underscore the concept.
Large successful companies have high absolute prices, and small, less successful companies have low absolute prices. Your ownership for the same dollar investment is proportional to the size of the company.
2️⃣ P/E Ratio — the relative price that matters.
Market cap is the absolute price. P/E is the relative price — how cheap/expensive the company is compared to its earnings.
Apple P/E ≈ 30 → You pay $30 for every $1 it earns annually.
Palantir P/E ≈ 620 → You pay $620 for every $1 it earns annually.
Ball Corp P/E ≈ 4 → You pay $4 for every $1 it earns annually.
It doesn't matter if you buy $500 of stock of $1M of stock. You are still signing up for this same ratio.
High P/E stocks are “growth” stocks, while low P/E stocks are “value” stocks.
Neither is inherently better. Growth is exciting (Tesla, Palantir), while value is expected to be steady-eddy and somewhat boring (mason jars and toothpaste). But beware, growth does not mean the stock is expected to grow at a higher rate: it just means it's relatively more expensive relative to some business metric like earnings, while value means relatively less expensive.
3️⃣ Multiple Expansion — how prices change
If the P/E multiple rises, either:
Price goes up while earnings stayed flattish (investors expect more growth), or
Earnings fall while price stayed ~ the same
If P/E falls, it’s the reverse and the multiple compresses.
This highlights the dynamic factors that impact relative prices. If a global theme or likely outcome begins to look more appealing into the future, investors are likely willing to pay more for $1 of today's earnings.
But alternative choices matter to investors. What if say, the yields available to investors on risk-free bonds go up, we might expect multiples on stocks to compress as investors say — why would I still pay $1 for that same company's earnings when my alternative return on $1 into a guaranteed return via risk-free bonds, is now higher?
So multiples can expand or compress based on things directly related to the company's business (like how they might use A.I. in the future), and things unrelated, like interest rates/yields available elsewhere.
Nvidia’s market cap has recently exploded to $4.5T — the most valuable company in the world — but its P/E actually dropped from 2023. It got relatively cheaper even while becoming absolutely more expensive.
Going forward, Nvidia's multiple might expand (P/E goes higher than 120) because people are willing to pay a higher price for a $1 of earnings today (numerator up), or because its earnings go down but investors continue to be willing to pay a similar price as today (denominator down).
OR — the multiple might compress because people are no longer willing to pay $120 for every $1 of earnings today (numerator down), or earnings increase yet investors aren't willing to pay more for the stock (denominator up).
Investing has a snakes and sparklers problem.
In the 2001 eponymous comedy, Joe Dirt (David Spade) wants to buy fireworks from Kicking Wing, but he only sells snakes and sparklers, which are basically kid's toys to a fireworks enthusiast like Joe.
Joe Dirt: What!? You need the good stuff that explodes, go boom!
Kicking Wing: Why is that good?"
Joe Dirt: You might as well as why are trees good? Why are sunsets good? They just are.
Sunsets are an absolutely good thing. Trees are an absolutely good thing. Thankfully as people, many absolutely good things are free to enjoy.
Apple is an absolutely good company. Unfortunately that doesn't give us much useful information as investors, because the price we have to pay adjusts accordingly.
I can tell you which company is more impressive and where I'd rather work, but we can't know whether Elf or Apple will be a better stock investment into the future.
Many investors care too much about the absolute metric of market cap, which is correlated to our familiarity with a company because its large, successful, and part of our everyday lives — when they should focus more on relative metrics to contextualize an investment decision.
How much would you pay today for $1 of earnings annually in the future?
Sure, Palantir (data integration and security technology) seems like a crazy innovative company. But a 620 P/E is off the charts.
Recall that Ball Corp.'s P/E, who makes jars and cans, has a P/E ≈ 4.
A well-functioning market has the job to make it so we can't decide that either is an obviously better investment.
And then, multiple expansion — which is just the direction of the numerator and denominator in a multiple like P/E — will tell the story of how investors are reacting to a company's business model through time.
My advisory firm has a foundational belief that the market does a good job at setting this equilibrium where greater companies have high absolute and relative prices, and crappier companies have lower absolute and relative prices.
So when I design stock portfolios for clients, I like both the Elfs and the Palantirs.
Not because I can predict winners, but because I can't. And because both absolute and relative prices matter — you probably can't, either.
End.
