How Does Market Value Work?
A company’s or an asset’s market value is the amount that investors are willing to pay for it, sometimes referred to as “open market valuation” (OMV).
Multiplying the number of outstanding shares by the current share price yields the market value, which is another name for the market capitalization of a publicly traded company.
It is somewhat more difficult to ascertain the market value of over-the-counter instruments like fixed income securities, in contrast to exchange-traded instruments like futures and stocks, whose market prices are widely disseminated and readily available.
Illiquid assets, such as real estate and businesses, are notoriously difficult to put a price on, so it’s not uncommon for people to hire real estate appraisers and business valuation specialists, respectively, to help with this process.
Gaining Insight into Market Value
Investors’ expectations for a company’s future success can be gleaned from its market value.
From the tiniest startups with market values below $1 million to the largest and most prosperous corporations in the world, the spectrum of market values is vast.
Multiples such as price-to-sales, price-to-earnings, enterprise value-to-EBITDA, and others that investors use to value businesses are what ultimately decide their market worth. The market value is higher when valuations are higher.
KEY POINTS
- Commonly used interchangeably with market capitalization, market value is the monetary worth of an asset as it trades on a market.
- Due to their dependence on a wide range of variables, including but not limited to economic conditions, physical operating conditions, and the ever-changing dynamics of supply and demand, market values are inherently unpredictable.
How Market Values Change Over Time
The business cycle is a major factor that causes market value to fluctuate significantly over time.
When the economy is in a recession, the market value drops, and when the economy is growing, the market value rises.
There are a lot of other variables that affect a company’s market value, including the industry in which it works, profitability, debt levels, and the overall market climate.
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Consider two companies, X and B, with yearly sales of $100 million each. However, if X is a rapidly expanding tech company and B is a staid retailer, then X’s market value will be substantially greater than B’s.
Using the previous example, Company X’s market value could be $500 million if its sales multiple was 5, and Company B’s market value could be $200 million if its sales multiple was 2.
The difference between a company’s market value and its book value or shareholders’ equity can be substantial.
When a stock’s market value is substantially lower than its book value, it indicates that the stock is being traded at a significant discount to its book value per share, which is generally seen as an indication of undervaluation.
Although a stock may be trading at a premium to its book value, this does not necessarily mean that it is overvalued.
The level of premium relative to the stock’s competitors and the industry in which the stock operates determine this.
The book value, sometimes called the explicit value, has a significant impact on the implicit value of a company, which is determined by the subjective opinions and analysis of analysts and investors.
This, in turn, determines the direction of the stock price movement.
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