What is Market Value?
Market value is usually used to describe how much an asset or company is worth in a financial market. It is mutually determined by market participants and is interchangeably used for market capitalization when dealing with assets and companies.
- Market value is usually used to describe how much an asset or company is worth in a financial market.
- The market value of a good is the same as its market price only when a fair market exists.
- Market value can be expressed in the forms of mathematical ratios such as P/E ratio, EPS, market value per share, book value per share, etc.
Relationship between Market Value and Market Price
On the other hand, market price refers to the price at which the exchange of goods takes place. It is determined purely by demand and supply, which means that the amount the buyer is willing to pay must be exactly equal to what the seller is willing to accept.
The market value of a good is the same as its market price only when a fair market exists. For a market to operate under fair or efficient conditions, certain criteria must be adhered to:
1. No distress
None of the parties to a contract of sale must be in a hurry or in need to complete the transaction. Usually, a distressed buyer or seller can make a wrong decision that does not reflect the market situation correctly.
2. Sufficient time, information, and market exposure
Both the buyer and the seller are given enough time to do their research, understand the market, analyze alternatives, and make an informed decision.
3. Mutually agreed price
None of the parties involved must be forced to make the transaction, and the final price decided must be agreed upon by both the buyer and the seller.
However, a fair market doesn’t always present itself.
How is Market Value Expressed?
Market value can be expressed in the forms of mathematical ratios that give the management insight into what the company’s investors think of the organization, both at present and in the future.
- Earnings per Share (EPS): EPS is calculated by allocating a portion of a company’s profit to every individual share of stock. A higher EPS denotes higher profitability.
- Book Value per Share: It is calculated by dividing the company’s equity by the total number of outstanding shares.
- Market Value per Share: It is calculated by considering the market value of a company divided by the total number of outstanding shares.
- Market/Book Ratio: The market/book ratio is used to compare a company’s market value to its book value. It is calculated by dividing the market value per share by the book value per share
- Price-Earnings (P/E) Ratio: The P/E ratio is the current price of the stock divided by the earnings per share.
How is Market Value Calculated?
There are multiple methods for calculating market value. They are as follows:
1. Discounted Cash Flow (DCF)
Under the DCF approach, the market value is a function of an estimate of the present value of future cash streams of a given company. It is done by projecting future cash flow, which is then discounted to reach its present value. The discounting rate depends on prevailing interest rates and the degree of risk associated with the business to be valued.
2. Capitalized Earnings Method
The capitalized earnings method is used for calculating the worth of a stable income-producing property. The net operating income accrued over a period of time is divided by the capitalization rate, which is an estimate of the potential return on investment.
Under the assets approach method, the fair market value (FMV) is calculated by computing the adjusted assets and liabilities held by a company. It takes into account intangible assets, off-balance sheet assets, and unrecorded liabilities. The difference between the FMV of the assets and liabilities is the value of net adjusted assets.
1. Public Company Comparable
The value of a business can be evaluated by comparing all the businesses operating with the same scale in the same industry or region. After establishing a peer group of comparable companies, ratios such as EV/EBITDA, EV/Revenue, P/E ratio can be calculated.
2. Precedent Transactions
Under the precedent transactions method of valuation, the price paid for similar companies in earlier transactions is used as a reference. The method is most commonly used before a prospective merger and acquisition deal. It is very important to identify a transaction within the same industry, a similar scale of operations, and involving the same type of buyer.
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