What is Market Value: Clear Explanation and Calculation Methods

So, if you consider buying stocks for long-term investment and want to determine companies worth your money, you are in the right place. In this article, we will answer the following questions:

• What is market value? 
• What factors affect the market value of stocks? 
• Why should traders monitor the market value of stocks?
• What is the difference between market value and price?
• How is market value determined?

What is the Market Value? Definition

What is a stock's market value? Formally, it is the price that investors are willing to pay for an asset. It is determined by considering all sources of its funding: debt obligations, preferred stock, minority interests, and common stock.

What is the Market Value of a Company?

The market value of a company is the same as the market value of shares. Usually, the number is influenced the most by the potential of a company for investors, considering its profitability, debt, growth prospects, etc.

It’s important to choose the right method for estimating the market value of a company to eliminate ambiguity in its valuation.

Usually, buyers and sellers estimate the value of goods differently. Buyers want to pay less, and sellers hope to get more. The main purpose of determining market value is to give a fair estimate of the value or worth of an asset. Simply put, it is the price for which an item would normally be sold for. Buyers have the option to pay, and sellers can accept more or less than the market value.

What is a Stock's Market Value?

Stock market value is the price at which shares are bought and sold on the secondary market. Unlike other types of value, stock market value is formed in the process of stock trading. It depends on supply and demand for the stock of a given corporation and is updated daily. In some cases (for example, in stock exchanges terms), a different market value definition is used — quote. You should buy a stock when its quotation falls briefly and sell it when it rises.

Market Value vs. Market Price

Price is what you pay, and value is what you get.

This is perhaps the most fundamental difference between the concepts of market price and value. When you buy a product or stock, you pay a certain market price. Particularly when it comes to stocks, the market price is based on a combination of subjective and objective factors. In fact, you pay the price or market value of a stock. But value is what is in the asset. The value is determined by the value of the stock, which in turn depends on how much cash flow the company can generate in the future.

There are different criteria and processes of estimating the value of the stock. However, the buyer is primarily interested in earnings prospects, potential dividends, and the company’s financial condition. These three fundamental factors determine the estimated price of the stock since they guide investors, comparing stocks to other investment opportunities available to them.

Of primary interest to investors is the market value of equity, i.e., the price at which a stock is sold and bought in the market.

What Affects the Market Value? 8 Essential Factors

Demand

Demand is determined by consumer preferences, which depend on what income this business brings to the owner, at what time, what risks it carries, what opportunities to control and resell this business.

Income

The income that an owner of a facility can earn depends on the nature of the operation and the opportunity to make a profit on the sale of the facility after it is used. Operating profit, in turn, is determined by the ratio of income and expense streams.

Time

Of great importance to the formation of the value of the enterprise is the timing of revenue streams. One thing if the owner acquires assets and quickly begins to profit from their use, and it is another matter if the investment and the return of capital are separated by a significant period.

Industry Risks

The company's profits may decline in the future, sometimes, unpredictably, negatively impacting its share price. Among widespread risks are competitive threats, product substitution, industry prospects in general, etc.

Control

One of the most critical factors affecting value is the degree of control that the new owner has.

If a business is purchased as individual private property, or if a controlling interest is purchased, the new owner has substantial rights such as the right to appoint managers, determine their salaries, influence business strategy and tactics, sell or buy its assets, restructure or even liquidate the business, decide whether to take over other businesses, determine dividends, etc. Because you buy more rights, the value and price are usually higher than when you buy a non-controlling interest.

Liquidity

One of the most important factors in estimating the market value of a business and its property is the degree of liquidity.

The market liquidity of assets affects their price and expected return. Investors require higher returns on assets with lower market liquidity to compensate for the higher cost of trading those assets. That is, for an asset with a given cash flow, the higher its market liquidity, the higher its price, and the lower its expected return. 

Restrictions

The value of a business responds to any restrictions the business has. For example, if the government restricts the price of a business's products, the value of that business will be lower than if there are no restrictions.

Supply and Demand Ratio

Demand for a business, along with utility, also depends on the solvency of potential investors, the value of money, and the ability to raise additional capital in the financial market. An investor's attitude toward the level of return and the degree of risk depends even on age. Younger people tend to take more risks for higher returns in the future.

Examples of rises and falls in stock prices

• On March 12, the day after Donald Trump banned travel from Europe to the U.S., U.S. airline stocks reacted to the market situation and dropped significantly in value: United Airlines — almost 16%, Delta Air Lines — almost 15%, American Airlines — 19%, Southwest Airlines — 14.3%.
• Because of the coronavirus situation and unfavorable market conditions, oil and gas companies also suffered enormous losses. The closure of transport links and the shutdown of several production facilities led to a decrease in demand and, consequently, a drop in oil prices. For example, shares of Continental Resources, one of the largest U.S. shale oil producers, fell by 73% over the past three months. Amid the spread of the coronavirus, the company refused to pay a quarterly dividend and said it would cut production by about 30%.
• In the face of self-isolation, many have turned their attention to virtual entertainment, including video games. One of the beneficiaries of this process is Electronic Arts, the largest representative of the gaming industry. Since the beginning of the year, Electronic Arts shares have risen 7% to $114 per share.
• The growing demand for electric cars drives up the price of its largest manufacturer, Tesla. At the very beginning of 2020, Tesla shares could be bought for $84.90, but now the price of one share exceeds $700. Meanwhile, experts believe that Tesla stock hasn't exhausted its potential and will continue to grow as its share in the electric car market increases.
• Against the background of the U.S. authorities' decision to allow the sale of tobacco heating systems, iQOS shares of its manufacturer Philip Morris (PM) rose by 2%. The fact is that this position of the government opens a new financial market for PM, which is beneficial to the profitability of the company, and, accordingly, stimulates the growth of the value of their shares.
• Apple's revenue for its first fiscal quarter of 2019-2020, which ended December 28, 2019, was $92 billion, a record high for the company. The positive report encouraged investors to buy Apple stock, which immediately responded with an increase of about 2%.

How to Calculate Market Value?

A very common question among investors is how to calculate the market value of a company

There are several ways to calculate the market value of a firm and market capitalization. This is important for every investor who wants to know if it makes sense to buy or sell a stock.

Estimating a company's value based on its stock price

If a company's stock is already traded on a stock exchange, the easiest way to calculate its market value is to multiply the number of shares outstanding by the current price at which the stock is traded on the relevant exchange. If the shares are only traded on an exchange, the trading volume may be so small that the trading prices are not realistic.

Valuing a company by sales multiples

A reasonable alternative is to estimate market value for those companies whose trading volume matches their market prices. This latter approach may be fraught with some uncertainty since the more reliable companies may reasonably cost a lot. In that case, the market value is likely to be excessively high.

Market valuation company value by comparison companies

Another approach to estimating market value is to look at what similar companies sell for as a percentage of their sales and use that ratio to determine the value of the business. The main drawback of this approach is that the best companies are likely to be sold first and therefore get better multiples; companies sold after the first tranche do not perform as well and thus probably should be sold at lower multiples.

Final Thoughts

So what does market value mean? Hope we clarified that in the article. Moreover, we’ve discussed why it is important to conduct market value accounting and explained how a stock's value differs from its price.

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