Market value is a common term used in value investing to describe how much a company or asset is worth on exchanges and financial markets. Essentially it is the value of a security in the eyes of market investors. Understanding the current standing of a business in its particular industry and the broader market is important when making investing decisions.
What Is Market Value?
Market value, also referred to as OMV, market capitalization, or “open market valuation,” is the price of an asset in an investment marketplace or the value the asset has within a community of investors. It is calculated by multiplying current share price in a marketplace by the number of outstanding shares. Read on to learn what market value is and how to calculate market value.
The market value represents the price that investors will pay for an asset, and therefore changes significantly over time. The more investors will pay for the asset, the higher the market value.
What investors are willing to pay depends on various factors, including the fundamentals of the asset itself, as well as the business cycle and current levels of demand for that asset. Market value could be anything from under $1 million for small businesses to more than $1 trillion for large corporations.
It’s easy to determine the market value of frequently traded assets (by looking at their current prices), but harder to determine the market value of illiquid assets, such as real estate or a company, that don’t trade very often. Market value per share is a company’s market value divided by its number of shares.
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Factors that Impact Market Value
Many factors determine market value, including a company’s profitability and its debt levels. Market value fluctuates significantly over time. Market values often move in tandem with the overall market sentiment.
During bull markets or economic expansions, market values often increase, and during bear markets they go down. Other factors influencing market value include:
• The company’s performance
• Long-term growth potential
• Supply and demand of the asset
• Company profitability
• Company debt
• Overall market trends
• Industry trends
• Valuation ratios such as earnings per share, book value per share, and price-to-earnings ratio (P/E ratio)
Earnings per Share
The higher a company’s earnings per share, the more profitable it is. A more profitable business has a higher market value, and vice versa.
Book Value per Share
Investors calculate a company’s book value per share by dividing its equity by its total outstanding shares. A company with a higher book value than market value may have an undervalued stock.
Price-to-Earnings Ratio (P/E Ratio)
Investors calculate P/E ratio by dividing a company’s current stock price by its earnings per share amount. A higher P/E ratio means a stock’s price market value might be high relative to its earnings.
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How Is Market Value Calculated?
There are multiple ways to calculate market value. Here’s a look at a few of them:
Income method
There are two methods of calculating market value using income:
• Discounted Cash Flow (DCF): To find discounted cash flow, investors project a company’s future cash flow and then discount it to find its present value. The amount it gets discounted reflects current market interest rates along with the amount of risk the business has.
• Capitalized Earnings Method: With capitalized earnings, investors find the value of a stable, income-producing property by taking its net operating income over time and dividing it by the capitalization rate. The capitalization rate is an estimate of how much potential return on investment the asset has.
Assets Method
Using the assets approach, investors find an asset’s fair market value (FMV) by determining how many liabilities and adjusted assets a company has, including intangible assets, unrecorded liabilities, and off-balance sheet assets.
Market method
Using a market-based approach, there are a few more ways market value can be determined:
• Public Company Comparable: This company compares similar businesses that are in the same industry or region and about the same size. Ratios like P/E, EV/Revenue, and EV/EBITDA can help compare all the similar companies.
• Precedent Transactions: Using the precedent transactions method, market value reflects how much investors paid for other similar company’s stock in previous transactions. Investors can get a sense of how much a company’s value is by looking at similar companies.
Example of Market Value
Using the capitalized earnings valuation method, here’s an example of the market value calculation. The formula used when calculating via capitalized earnings is as such:
Market value = Earnings/capitalization rate
Earnings are rather self-explanatory, and the capitalization rate is the required rate of return for investors, a number reached by subtracting a company’s expected growth rate from the investor’s expected rate of return. For this example, we’ll make things simple and say that the capitalization rate is 10%, and the company’s earnings are $1 million
Using the formula: Market value = $1 million/10%
That calculates to $10,000,000.
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Limitations of Market Value
Market value is a very useful tool for understanding how much a company is worth and whether it is a good time to invest or sell its stock. However, it has a few limitations:
• Fluctuation: Company stocks go up and down every day, and, therefore market value also always changes. Various factors affect market value, and it is very dynamic, which is important for investors to keep in mind when making trading decisions.
• Precedent data: It’s easier to find market value for established businesses because it requires historical pricing data to find it. New businesses don’t have such data, making it harder for investors to determine their market value.
The Takeaway
Market value is very useful for analyzing a stock. It is easiest to calculate market value of assets such as stocks and futures that are traded on exchanges because it is easy to access their market prices. Market value for less frequently traded assets can be difficult and requires some assumptions and calculations.
Calculating market value can be useful for investors of all stripes, but it can be easy to get lost in the math. Be sure to double-check your math and consider the limitations of market value before making investing decisions.
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FAQ
Is market value the same as market capitalization?
Market value is the price at which a buyer purchases an asset, and can refer to a company or a security such as a stock, future, or asset. Market cap is the value of the total number of outstanding shares of a company, based on their current market value.
Is market value the same as book value?
Market value and book value per share, or explicit value, are different and can be very different amounts, but they are often used in conjunction by investors looking to gain an understanding of an asset’s value. Book value is the net value of a company’s balance sheet assets, while market value is the price at which a buyer purchases an asset.
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