Coming up with a reasonable valuation for a business can often be a challenge. The best indicator of company value is what market participants are willing to pay for it, and so companies whose shares are listed on public stock exchanges have an advantage in giving interested investors an estimate of their value that's easy to calculate. Below, we'll look at how to calculate the market value of a firm's equity and how it relates to other valuation methods.
The simple calculationFor companies with publicly traded shares, calculating the market value of equity is a trivial exercise. The current price per share for the stock will be available from easily accessible sources. The company's financial statements will include information on how many shares of stock are outstanding. Multiply the number of shares by the price per share, and you'll have the market value of equity, also known as market capitalization.
Bear in mind that in some situations, the answer will be more complicated. For example, if a company has multiple classes of common stock, you'll have to account for the price and number of shares in each class. Similarly, if a company issues preferred stock in addition to common stock, then you'll need to gather information on both types of equity in order to come up with the total firm value.
Comparing market value with other valuation methodsThose with familiarity in accounting will understand that the market value of a company's equity is only one measure of its valuation. Alternatives can shed further light on its financial condition.
For instance, many investors look at book value, which you can derive by taking the shareholder equity on the company's balance sheet and dividing it by the number of shares outstanding. Book value is less volatile than market value because numbers on financial statements are calculated on a quarterly basis, smoothing out movements and taking away the daily perturbations of the market.
However, accounting conventions put limitations on the usefulness of book value. Because some assets aren't subject to mark-to-market requirements, book value can reflect outdated valuations on those assets. Therefore, it can be entirely appropriate for shares to trade at a premium to book value in order to reflect accurate current values.
One limitation on market value is that transactions on the open market involve small minority interests in publicly traded companies. Typically, when an acquiring company makes a takeover bid, it will offer a premium to the recent market price. That premium reflects the added value of having a controlling interest versus being a minority shareholder.
Looking at the market value of a firm's equity lets you compare the relative sizes of different companies more easily. It's not the only way to put a value on a company, but it gives a useful starting point for your research.
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