What is “Market Value”?
Market Value is the price that buyers are willing to pay for an asset in the marketplace, or the price that is currently offered (or paid) for an asset. If the asset is a traded asset (e.g. equity shares), the market value is obtained by looking at the current prevailing price i.e. the last traded price. This information is readily available for public companies but may be more tricky to calculate the market-value for non-listed companies.
In the context of a publicly-traded company, the market value is known as market capitalization (i.e., the total market value of a company’s outstanding shares, which is calculated as the current share price multiplied by the diluted number of shares).
Key Learning Points
- There is a difference between the market value and the book value of an asset
- There are two commonly used methodologies (Market Capitalization and Valuation Methodologies) to determine the market value of businesses
- The concept of Market Value enables a fair assessment of the worth or value of an asset or business, helps in making better investment decisions and understanding the relative size of a business
- The Market Value is a good indicator of the prospects of a business or company through the eyes of other investors
- Market Values change regularly driven by company specific factors such as growth prospects, cash flow, and debt management, as well as the wider economic outlook and macro landscape
Market Value vs. Book Value
There is nearly always a difference between book value and market value of an asset: the former is recorded at historical cost (original purchase cost) – recognized by a company on its balance sheet – which is adjusted for depreciation, amortization, depletion, or impairment, while the market value is based on the perceived demand for and supply of an asset, and fluctuates constantly.
For most assets and liabilities, book values are based on the historical (i.e. initial) cost of items. Companies report property, plant & equipment (PP&E) at their net book value, which is the cost of the asset less accumulated depreciation, amortization, depletion, or impairment.
A company could be considered undervalued if its market value was below that of the book value.
Market Valuation Methodologies
Given below are two commonly used methodologies (Market Capitalization and Valuation Methodologies) used to determine the market value of a business. These represent the current worth of a business based on the value of its assets and liabilities, future earnings potential, brand value, etc. The market value of a business is useful for various reasons such as stock purchases, M&A deals, leveraged buyouts, or IPOs.
Market capitalization is calculated as the current stock price multiplied by the diluted number of stocks and is the total market value of a company’s outstanding stocks.
The diluted number of shares is calculated as the basic number of shares (available in a company’s financial statements) plus financial instruments that could be converted into shares. These financial instruments include convertible securities, restricted stock units, and employee stock options.
Valuation techniques are used to calculate the market value of a business. This is useful in many contexts, including M&A, IPOs, equity research, and levered value. There are many valuation methodologies, some of which are market based such as price/earnings multiples, EV/EBITDA or price to sales. If a sector was trading on an average of 2.3x sales, then an investor could apply this ratio to Company X with Sales of US$200,000 and determine that its market value was US$460,000. Often investors compare several valuation methods to determine the market value. Market-based valuation methodologies include trading and transaction comparables. These business valuation techniques start with market prices for a peer group of businesses or transactions. A benchmark is established and used to arrive at a relative valuation for the business being valued.
Example: Calculating Equity Value
The equity value or market capitalization of Carne Inc. is calculated, based on the following information:
The share price of this listed company is US$6.50 per share.
The number of authorized shares (100,000) is the theoretical maximum number of shares that the company can issue. Further, as of the calculation date, the number of shares issued is 80,000.
In order to arrive at the equity value or market capitalization of Carne Inc. we need to first calculate the diluted number of shares outstanding. This is done by deducting the shares held in treasury (shares repurchased by the company) from the total number of issued shares.
Next, we need to multiply the share price with the diluted number of shares to arrive at the equity value or market capitalization of this company.
The equity value or market capitalization of this company is US$390,000.
Why is Market Value Important?
By determining market value, one gets a fair assessment of the worth of value of an asset or business. Further, comparing the market value of businesses or assets with the value determined using various valuation techniques enables investors and analysts to make better investment decisions.
Market value also helps in categorizing businesses by their relative size. For example, stocks of listed companies are categorized into large-cap, mid-cap and small-cap – based on their market capitalization.