Market value is determined by the price of an asset in the marketplace, reflecting the prices buyers are willing to pay and sellers are willing to accept. In the case of publicly traded companies, market value specifically denotes their market capitalization, calculated as the product of outstanding shares and share price.
When it comes to publicly traded companies, the market value meaning refers to the market capitalisation of that company. You can calculate it by multiplying the total number of shares in the secondary market with the current price of each company stock.
What is market value?
Market value, or market capitalisation, is a financial metric that reflects the perceived worth of a company or asset as determined by market participants. It's calculated by multiplying the total number of outstanding shares by the current market price per share. Essentially, it represents the collective assessment of investors regarding the future financial prospects and performance of the company.
Examples of market value
- Example #1
Suppose you have a rare edition of a sports journal. The market value of your sports journal will be the price at which you could sell it to a buyer. It is important to note that the price at which you could sell the book is the agreed-upon price between you and the buyer. That is the market value of your sports journal.
Now, suppose the same rare sports journal is currently selling at Rs. 10,000 at a renowned auction website. With the win of the Indian cricket team, the demand for that rare sports journal shot up significantly. With more buyers in the market than before, you or other limited sellers having this rare journal decide to increase the price to Rs. 15,000. If the buyers also buy the sports journal at Rs. 15,000, the market value of the same increases to Rs. 15,000.
In the same way, the demand for the journal may fall with time. Now, the buyers are not willing to cough up Rs. 10,000 to buy it, no matter how rare it is. This may cause sellers to decide to lower the price to Rs. 7,000 so that more buyers are willing to buy rare sports journals at a lower price. If both buyers and sellers agree on Rs. 7,000, the market value of the journal will be Rs. 7,000.
This shows that the market value of a product or service may change due to various factors, including demand, supply, and other market conditions. - Example #2
Let us consider a hypothetical example of an Indian corporation ‘XYZ’. XYZ is one of the leading Indian companies in the IT sector. Assuming this hypothetical company was listed on the Indian stock market at Rs. 145 per share in 1993. The market capitalisation of XYZ was very low at that time. However, recently, the market capitalisation of XYZ touched Rs. 7.45 lakh crore as the stock price of the company hit an all-time high (ATH) of Rs. 1,755 per share. The meteoric rise in the market cap of XYZ shows that the company’s market value increased significantly since its listing back in 1993.
The calculation of the market value or market cap of XYZ is done in this simple way.
In the secondary market, there are 10,000 shares available. When the XYZ stock price reached Rs. 1,755 per share, the market value was calculated as (Rs. 1,755) x 10,000 = Rs. 1,75,50,000.
Also read about: What is market volatility?
Importance of market value
Market value is crucial for investors as it reflects the current market assessment of a company's worth. It is calculated by multiplying the current market price of shares by the total outstanding shares. This metric helps investors assess risk, compare companies, and identify market trends. Market capitalisation, a key component of market value, influences stock liquidity, index composition, and financial decision-making. It also impacts investor perception and can affect stock prices. Understanding market value is essential for informed investment decisions and assessing the risk-return profile of stocks.
Dynamic nature of market value
Market capitalisation, a key financial metric, exhibits substantial volatility over time, mirroring the broader economic landscape. During periods of economic downturn, or bear markets, market values tend to decline, often following recessions. Conversely, in periods of economic expansion, or bull markets, market values typically rise.
It's important to note that a firm's market value can diverge significantly from its book value or the equity held by shareholders. When a stock's market value is significantly lower than its book value, it may be considered undervalued. This scenario implies that the stock is trading at a discount to its book value per share, presenting a potential investment opportunity.
How to calculate market value?
Market value reflects the worth of a company or asset in the current market. It is determined by various factors, such as supply and demand, economic conditions, and the asset's characteristics. Market value is essential for investors to make informed decisions about their investments. Here is how market value can be calculated:
- Valuation by stock price
Valuation by stock price is a widely used method to calculate market value. It involves multiplying the current stock price by the total number of outstanding shares. For example, if the stock price of a company listed on the National Stock Exchange (NSE) is Rs. 500 and there are 10 million shares, the market value would be Rs. 5 billion. This method is commonly used for publicly traded companies listed on Indian stock exchanges. - Valuation by competitive analysis
Valuation by competitive analysis involves comparing the financial metrics of a company with those of similar companies listed on Indian stock exchanges. This method helps to determine the market value by using multiples such as price-to-earnings (P/E) ratio, price-to-book (P/B) ratio, and price-to-sales (P/S) ratio. For instance, if a comparable company in the same sector has a P/E ratio of 20 and the company being valued has earnings per share of Rs. 20, the estimated market price would be Rs. 400 per share.
Also read: What is Market Risk definition?
How to qualitatively assess market value?
Qualitatively assessing market value involves various formulas, ratios, and mathematical tools used by investors and analysts. Some of the most common ratios and values are provided below:
- P/E ratio
One of the most popular ratios to qualitatively assess market value is the P/E ratio. It signifies the amount an investor is willing to pay for the profits made per share.
The formula is given by:
P/E ratio = Market price per share / Earnings per share (ESP)
A higher P/E ratio (compared to the competitors or industry average) indicates that the entity is fundamentally stable. - EV/EBITDA ratio
EV/EBITDA, also known as the Enterprise Value, is often used when a company is about to be acquired. The EV/EBITDA ratio is employed to gauge the company’s value in terms of its debt, equity, and earnings.
The formula is:
EV/EBITDA = (Market value of equity + Market value of debt) – cash / EBITDA
If the company’s EBITDA is high, it could mean that the investor is spending more per profit unit, which signifies that the company is overvalued. - Price/book value
The price/book value (or P/B ratio) indicates what an investor is ready to pay per unit share of the asset of a company.
This value is given as:
Price/book value = Market price per share / Book value per share
Similar to other financial ratios, the company’s P/B ratio can oscillate or underperform for several reasons. For this reason, investors must understand the P/B ratio rather than just take it at face value.
Also read: Difference between equity market and debt market
Market value vs. market capitalisation
Market value and market capitalisation are two distinct financial metrics used to assess a company's worth. Market capitalisation, also known as market cap, is the total value of a company's outstanding shares, calculated by multiplying the number of shares by the current market price of a single share. On the other hand, market value is a more comprehensive measure that considers factors such as price-to-earnings ratio, return on equity, and long-term growth potential to determine a company's monetary value. While market capitalisation reflects the equity value of a company, market value provides a broader picture of its financial standing, making it a more nuanced measure of a company's worth.
Market value and a value trap
While market value reflects public perception of a company's performance, it does not necessarily represent its true potential. Investors often view companies with low valuation metrics, such as the price-to-earnings ratio and price-to-cash-flow ratio, as strong candidates for investment, believing these metrics suggest the shares are undervalued and likely to yield future capital gains.
However, low financial ratios can also indicate significant systematic risks associated with the company’s management. Without a thorough analysis of the intrinsic values of such companies, investors may face substantial losses if the company’s productivity declines further.
Why does market value matter to investors?
Market value is crucial for investors as it reflects the collective perceptions of market participants about the value of an asset. It is determined by the forces of supply and demand in the marketplace and is influenced by various factors, such as economic conditions, company performance, interest rates, and investor sentiment.
Market value is important for investors because it helps them make informed decisions about their investments. Here are some other reasons why market value matters to investors:
- Reflects investor sentiment: Market value reflects the sentiment of investors about a company's prospects. If investors are optimistic about a company's growth prospects, they will drive up the market value, making it a more attractive investment.
- Informs investment decisions: Market value helps investors determine whether a company is undervalued or overvalued. This information can guide investment decisions, such as buying undervalued stocks or avoiding overvalued ones.
- Assesses company performance: Market value provides a snapshot of a company's financial health and performance. It helps investors evaluate a company's growth potential, profitability, and overall financial standing.
- Diversification: Market value helps investors diversify their portfolios by identifying assets that are undervalued or overvalued. This can help reduce risk and increase potential returns.
- Long-term growth: Market value is a key indicator of a company's long-term growth potential. Investors can use market value to assess a company's ability to generate returns over time.
Also read: What is Liquidity Risk?
Pros and cons of market value
Advantages of market value
Market value provides a valuable benchmark for assessing whether a company's shares are overvalued or undervalued relative to their perceived intrinsic worth. By comparing market value to fair value, traders and investors can identify potential mispricing opportunities. When the market corrects, these disparities can offer lucrative investment prospects.
Disadvantages of market value
To accurately determine market value, historical data is essential for establishing a comparable benchmark. Without a reliable reference point, market value becomes a less effective indicator of investment attractiveness. Additionally, market value is inherently subjective, as share prices are driven by fluctuations in supply and demand. This means that the market value of an asset reflects only its perceived value, not necessarily its underlying fundamental worth.
Limitations of market value
Market value has several limitations that investors should be aware of:
- Difficulty in determining the cost of capital: Market value requires an accurate estimate of the cost of capital, which can be challenging to determine, especially for companies with complex financial structures.
- Fluctuations: Market value can fluctuate rapidly based on market conditions, making it difficult to make long-term investment decisions.
- Lack of precedence: New products or unique items often lack historical pricing data, making it difficult to establish a market value.
- Adjustability: Market value can be influenced by external factors like supply and demand, making it difficult to predict future market performance.
- Systematic risks: Market value does not account for systematic risks associated with an investment, which can lead to unexpected losses.
- Overemphasis on short-term performance: Market value can focus too much on short-term performance, neglecting long-term growth potential.
Key takeaways
- Definition: The price at which an asset can be bought or sold in the open market.
- Publicly traded companies: Determined by market capitalisation (number of shares * share price).
- Factors influencing market value: Capital costs, consumer spending, supply and demand dynamics.
- Challenges: Assessing market value for illiquid or non-fungible assets, such as real estate or private businesses.
Final words
Market value plays an important role in the world of finance and economics. This basic but crucial concept is used by investors and market analysts to understand a company’s worth. It helps a stock investor understand one of the most important fundamental aspects of a company. Many other investors (including real estate investors) use market value data to determine the worth of a property and other assets. Depending on various factors, such as demand, supply, investor perceptions, and economic conditions, the market value of a stock, property, or other asset may change.
You should know what market value is and how to calculate it because this will enable you to assess the financial health of entities and consequently make informed investment decisions.
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