"Stock Traders are always trying to time the market. But an investor tends to be thinking bigger, more broadly, and more holistically."
-Hendrith Vanlon Smith Jr
If one wants to purchase a stock and is figuring out if it is worth the investment, then evaluation of the standing of the company with respect to its competitors in the same industry is one of the deciding factors for such an investment.
In order to look at the bigger picture, Market Value should be observed. The right investing opportunities will give an individual a leg up in the business world and this can be achieved by observation of Market Value. In this blog, you will learn more about Market Value.
What is Market Value?
The worth of an asset in the financial market is known as Market Value (also known as 'open market valuation' or OMV). When both assets and companies are being talked about, then it can be referred to as market capitalization. It is determined by the participants in the market.
The Market Value of a company is a good indicator of the perception of the investors in relation to its business prospects. There is a huge range of Market Value in the marketplace. Small companies have low Market Value and large companies have very high Market Value.
Market Value depends on a large number of factors, therefore, it is said to be dynamic in nature. Economic climate, dynamics of demand and supply and physical operating conditions are some of the factors.
It can be determined by different multiples or valuations granted to companies such as price-to-earnings, price-to-sales, enterprise-to-EBITDA, etc. When appraisal is higher, then market value is also higher.
Market Value and other Terms
Relationship between market price and Market Value
Market price is determined by demand and supply and it is the price at which exchange of goods and services takes place. The amount that the buyer is willing to pay for the goods must be exactly equal to the amount at what the seller is willing to accept.
When a fair market exists, then the Market Value of the goods are equal to the market price. For a market to be fair, there must be certain criteria that must be followed. These criteria are given below.
During a sale, there must be no sense of hurry between both the parties during the course of transaction. Wrong decisions can be made if the buyer or the seller are distressed which will not be a true reflection of the market situation.
Sufficient information, time and market exposure
Both the seller and the buyer should spend sufficient time studying and analyzing the market while observing all the alternatives to make a well informed decision.
Mutually agreed price
The transaction must not be forced on any party. Both the buyer and the seller should decide on the final price together.
Relationship between Value Trap and Market Value
Market Value can reflect the perception of the public regarding the performance of a business or company in the market but it does not represent the true potential.
People consider that a company is doing well if it shows low evaluation metrics like price to cash flow ratio and price to earning ratio. These metrics show that the share is undervalued in the market. This makes people believe that investing in such companies will help them achieve capital gains in the future.
High systematic financial risks can also be indicated by such ratios due to management of the company. Analysis of the intrinsic values of the company should be done otherwise hefty losses will be suffered by the investors if the productivity of the company falls further.
Fair Market Value vs Market Value
By fluctuations in supply and demand, the asset's Market Value can be determined. It can be used to represent whether someone is willing to pay for an asset, not the perceived value or the intrinsic worth.
The general measurement of the value of an asset that is agreed by both buyer and seller is known as fair Market Value. Fair Market Value is more stable than Market Value, since Market Value is more affected by supply and demand.
Book Value vs Market Value
The book value and stock Market Value of a company are significantly different. It is explained in detail below.
The maximum number of investors that are willing to pay for stocks or ownership of one unit of the company is represented by Market Value of shares.
The amount of gain as returns received by the investors if the company liquidates its assets which is in respect to the percentage of ownership as earned through the shares is represented by book value.
A comprehensive idea about the return of investment which was undertaken by an individual based on the Market Value of shares is provided by book value.
If bankruptcy occurs, the equity shareholders are paid back and hence there is relatively low chances of high ROI, since such a situation indicates financial turmoil.
Analysis of the book value of a company and division of book value by the number of outstanding shares gives an understanding of the security of the investment corpus, which mitigates the risk factor.
Face Value vs Market Value
People are often confused between face value and Market Value. There are huge differences between the two terms.
The present value of the trading of the stock is known as Market Value. The original value of the stocks when funds were raised by the company is known as face value.
The value is decided and determined by the company during the time of issuance of shares.
Face value is not fixed or bound by market conditions and is affected by a proportion to the stock split ratio.
Face value is generally below Market Value. In the case of penny stocks, it is equal or higher.
Equity share capital can be calculated by division of face value by total number of shares.
Market Capitalization vs Market Value
Many people use the terms Market Capitalization and Market Value interchangeably. The difference between Market Capitalization and Market Value is given below.
Multiplication of the number of shares outstanding with the current price of a single share gives the company's market capitalization. Only the equity value of a company is measured by market capitalization.
Market Value provides a broader view of a company's financial standings. It depends on the state of the economy and falls during times of recession and rises during times of expansion.
Market perception influences Market Value more than market capitalization.
Expression and Calculation of Market Value
Expression of Market Value
Mathematical ratios are used for expressing Market Value. This gives the management information about what the investors of the company think about the organization, both in the future and at present time. There are a number of factors which are used to express Market Value. They are given below.
Earnings per share (EPS)
EPS can be calculated by allocating every individual share of stock a portion of the company's profit. A higher EPS signifies higher profitability.
Book Value per share
Division of the company's equity with the total number of outstanding shares gives the book value per share.
Market Value per share
Division of the Market Value of a company by the total number of outstanding shares gives the Market Value per share.
Division of the Market Value per share by the book value per share gives the market/book ratio. The Market Value is compared to the book value by this method.
Price Earnings (PE) ratio
Division of the current price of the stock by the earnings per share gives the Price Earnings ratio.
Calculation of Market Value
Calculation of Market Value
The Market Value can be calculated by different methods. Some of them are given below.
The tools for income approach are given below.
If one calculates via the DCF approach, the Market Value is taken as a function of an estimate of the present value of cash streams in the future of the company.
It can be done by projection of future cash flow which is later discounted to reach the present value. The discounting rates depend upon the degree of risk associated with the business which is under evaluation and on the prevailing interest rates.
For calculating the worth of an income producing, stable property, capitalized earnings method is used. It is done by the division of net operating income achieved over a period of time by the capitalization rate. An estimate of the potential return on investment is known as capitalization rate.
By the Assets Approach method, the fair Market Value (FMV) can be calculated by computing the liabilities and adjusted assets of the company. Intangible assets, unrecorded liabilities and off-balance sheet assets are taken into account. The difference between the FMV of the liabilities and assets is the value of the net adjusted assets.
The tools for market approach are given below.
By comparison of all the businesses operating with the same scale in the same region or industry, the value of a company can be evaluated. After establishing such a group of comparable companies, the ratios required for Market Value such as EV/Revenue, EV/EBITDA, P/E ratio can be calculated.
By the precedent transactions method of evaluation, the price paid for comparable companies during earlier transactions is used as a reference.
In case of a prospective merger and acquisition deal, this method is commonly used. The transaction should be identified within a similar scale of operations, in the same industry which involves the same type of buyer.
Importance and Limitations of Market Value
The importance of Market Value is given below:
The amount of individuals willing to pay security to a corresponding seller in terms of stock exchange is indicated by the basic Market Value of shares.
High Market Value correlates to increasing demand for the particular stock in the market. In such cases, investors are optimistic about the future performance.
In case of rise in stock prices, the supply of respective shares is low and the people holding the shares are reluctant to sell their shares for fear of losing capital gains.
The limitations of Market Value are given below:
While choosing shares for an investment portfolio, merely looking at the stock Market Value is not sufficient. This is because there is the risk of falling into a value trap.
Only market fluctuations and the corresponding effect on share prices are taken into account.
Systematic risks after taking up such investments are not properly identified with such tools.
Intrinsic value tools are required for in depth analysis.
Also Read | Economic Value vs Market Value
Market Value can be used alongside other measurements for assessment of a firm's asset evaluation. Clarity and transparency is given to both buyers and sellers by this metric. It also fluctuates with time and depends upon different factors like industry and economic conditions.
A fair and transparent assessment of the worth of a company is given by Market Value. It is also subjective. The investors need to decide for themselves the importance of the metrics and which metrics should be observed while making financial decisions.
Market Value has a dynamic nature and can fluctuate greatly in a given span of time. It is significantly affected by the business cycle.