Understanding the Market Value of a Company
Every business, regardless of the size or the sector or the domain, has a valuation. From Fortune 500 giants and modern day unicorns through the innumerable mid-sized company’s right down to the countless smaller businesses worldwide, each has this one thing in common. They all have a market value that can range from billions of dollars to even a few thousands.
The concept of valuation, broadly, remains the same for all and it helps to understand how the market value of a company is arrived at to better appreciate them.
What is Market Value?
The market value or the valuation is the price that your business can command in the market and among investors. This is the value that the market assigns to your business and their monetary perception of its wellbeing. This is also the price that your business entity, its assets and its financial potential are worth.
Market values can be dynamic and are layered in its complexity. There is more than one factor that influences it and these can range from macroeconomic aspects to operational considerations. From the economic developments to market factors like demand and supply, valuation is a sensitive element. The conditions inside the company, the operational nuances and people issues within an organisation can all have short and long term implications.
From the standpoint of the market, in the case of a publicly traded company, this value is also the market capitalisation amount. It is especially helpful for to estimate the worth of the instruments like shares and futures that are traded in exchanges. However, it may not be of much use to ascertain the value of illiquid assets like real estate properties and over the counter instruments like fixed income securities.
Typically, market value is referred to with accounting terms and mathematical ratios like Price to Earnings ratio or P/E, Earning per share or EPS, Market value per share, Book value per share and Market to Book ratio, to name the most prominent ones.
How to Determine Market Value?
It is important to have an assessment of the market value of your business from time to time. Whether you have plans to sell off your company or are preparing for a merger or about to go public, you need to arrive at a valuation.
There are approaches and procedures that are employed for this. Following are some of the widely followed steps by companies.
➣ Value of assets
The asset a company owns forms an important part of its valuation. There are multiple heads of assets that range from immoveable ones like premises to the moveable segment comprising of inventory like equipment, furniture etc. To arrive at the net value of assets, the liabilities including debt need to be subtracted to get a clearer picture of the balance sheet.
Of course, the real worth of the business extends to other parameters beyond the assets themselves.
➣ Sales and revenue
What about the sales generated by a company from its products and services? These comprise of a substantial part of the market value of a company as the sales figure and the revenue generated reflects on its business performance too.
Based on your key metrics like annual sales and earnings, it is possible to ascertain a company’s market value for smaller businesses that are attempting this early in its life. Benchmarking the performance against similar companies in the same industry can bring you closer to the actual value.
➣ Price to earnings
The P/E or the price to earnings ratio refers to the multiple of the earnings a business generates. This is an important yardstick and is used widely as a reliable metric to gauge the health of a business.
➣ Non-financial considerations
Not all methods of assessing the market value of a company need to hinge around financial data alone. There are other factors also that can influence and define the valuation. The location of the business, any unique asset like a breakthrough patent and similar non-monetary edge the company possesses can also significantly increase the market value. These can particularly stand out in case there are talks of a merger or an acquisition.
Read Also: Horizontal Integration: What's it?
Commonly Used Ratios for Market Values
There are multiple approaches to understand and interpret market values. So, depending on the approach taken or the requirement, there is more than one ratio that is used to ascertain it.
Earnings per share: EPS can be a good indicator of the worth of a business as it tells you how valuable each share is in the context of the earnings each has generated.
Price to earnings: P/E is also an invaluable measure used to determine the stock value of a company. This is especially useful as a comparison tool against competition and other players in the same sector.
Book value: This tells you how valuable the share of a company is. If the book value is higher than the price the share is trading at, it means it is definitely a bargain price at which to buy it.
Dividend per share: When you have bought shares of a company, you are part owner of the business. Any profit made by the company not just results in your portfolio appreciating but also makes you eligible for any dividends declared by the company. The higher the valuation of the stock, the better the chances to get a good dividend payout is.
How to Calculate the Market Value
If your company is listed and traded on an exchange, there is a proven way to calculate the market value of your business. This can be validated by how the shareholders embrace your shares and market activity helps push its prices up.
To also understand, as a business owner, the value of your own holding in the company, the market value has relevance in that sense too. The current market price multiplied by the total holding can reveal that too.
Here are the steps involved to calculate the market value.
- Check the total number of outstanding shares of your company. The balance sheet will carry this number as will the major financial websites.
- Look up the latest stock price that also will be widely available on all media platforms including print, television and online.
- You will be able to get the figure of the market capitalisation by multiplying the number of outstanding stock with the latest market price. This also will be the market value of the company.
Pros of the Market Value System
Market value is a good indicator of the health of a company and a fair yardstick of measurement of its share price valuation. It can project a company in good light and positively influence the movement of its stock values. There can also be bloodbaths at the stock exchanges if the valuation takes a hit and starts to slide.
The market value, as an approach, is also a good way for anyone to understand how well a company performs. This can include the shareholder who wants to be sure if the stock he is purchasing is of a company he can trust to invest in. Similarly, the market valuation helps a new investor who wants to pump in capital into a company or another business that wants to partner, merge or take over.
Cons of the Market Value System
But it is also argued that the correct market value can be arrived at only on the basis of available information about the company. Often, there is a lack of adequate information because a business may be relatively new or has not been retaining books properly or has not been transparent. In such situations, arriving at a value can be inaccurate and even misleading to a potential buyer of its stocks or a potential investor.
Also, there can be situations where there is not enough data available about an industry or a company’s competitors to form a comparative assessment. This gap in information could also convey an incomplete picture of the market value.
Market Value, Book Value and Share Value
To understand the value of a company, there isn’t anyone calculation or indicator that can help you arrive at the exact amount or get the right picture. The commonly used values in business include the market value, the book value and the share value.
It can be too simplistic an approach to assume that the market value will perfectly mirror the book value and the share price or that each has an exact and direct correlation with the others. At best, these can be fairly accurate reflections of one another and help give a good enough direction as to how well the business is doing.
- Market value is the price at which an asset or a share or one unit of the company can be bought or sold.
- Book value is the amount received if the company liquidates its assets.
- Share value is the closing price of the company’s common stock multiplied by the accumulated shares for a trading day.
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