Market Value of Equity

What is Market Value of Equity?

A company’s Market Value of Equity is the current market price of company’s share multiplied by the number of all outstanding shares in the market. The market value of equity is also known as market capitalization.

Calculation

The formula to calculate Market Value of Equity is as follows

Market Value of Equity = Market price per share X Total number of outstanding shares

Let us understand it with an example – As on 18th April 2018, the share price of Walmart is US$ 87.89 then its market value of equity is:

Market Value of Equity = US$ 87.91 X 2.95 billion shares = US$ 259.34 billion

The market value of equity basically shows the size of the company.

Factors affecting Market Value of Equity

Market Value of Equity is extremely volatile as it is affected by the market price of a share. There are various factors that affect the market value of equity as follows:

Number of Market Participants

The larger the number of traders, investors, analysts who participate and follow the equity market, the more volatile and efficient a market is. In long term, these participants push the market price of the equity to reflect its actual value and thus bring market value closer to the intrinsic value.

Availability of New Information

When new information such as next quarter financial results of the company, company’s expansion plans, etc. is available to the market, it affects the price of a share of the company, thereby affecting the market value of the company. For example, Market Value of Apple Inc. is usually higher after the release of its new iPhones.

Cyclical Factors

Like businesses, equity markets also go through cycles of boom & recession. During the recession, the market value of equity is usually low whereas during bullish sentiment the market value is usually high.

Government Intervention

Government interventions extremely affect the market values of the companies. For example, some countries prevent foreigners from trading in their markets. The market value of companies in such closed markets will not be as volatile as the market value of the ones in open markets.

Market Value of Equity Vs Book Value of Equity

The market value of equity is very different from the book value of equity. Book Value of Equity of any company is calculated from its financial statements, whereas its market value of equity is calculated from the market price of each share.

To be precise-

Book Value of Equity = Total Assets-Total Liabilities

Market Value of Equity = Market price per share X Total number of outstanding shares

In practical terms Market Value reflects the theoretical cost of buying all shares of the company. This doesn’t necessarily mean that during a takeover or a merger the company will be sold at the market value. Thus we can say that market value or market capitalization is a measure of the size of the company, whereas book value is a measure of the accounting value of the company.

Market Value of Equity less than Book Value of Equity

When the market value of equity is less than book value, value investors would interpret it as an opportunity to invest. This is like a sure shot gain situation.

There is only one situation where the MV less than BV is justified. This situation could be fraudulent accounting and inflated figures of assets on the balance sheet. For example, a high-value machinery which is already obsolete in terms of its technology and has not been written off. The value of this machine should be zero in place of say $250 Million. This will keep the book value on a higher side but this value will not be realized if the assets of the business are sold at this time. Effectively, the company has not followed the accounting policies.

Market Value of Equity greater than Book Value of Equity

Conversely, when the market value of equity is more than book value, it implies a strong financial position for the company. It shows that investors believe in strong growth prospects of the company. This helps a company in obtaining additional capital at favorable prices. It cannot much speak of the under or overvaluation of the company till it is not seen with more metrics like industry averages of Market to Book Ratio, P/E Ratio, etc.

Market Value of Equity equal to Book Value of Equity

First of all, it is an imaginary situation. If it still exists for a company, it means there are no future prospects of a company. It is a company which may have shut its business and book value of assets and liabilities are no different than current market realizable value.

Per Share Market Price vs. Market Value

The term market value at times is interchangeably used for per share market price also. Many small investors get obsessed with the per share price of a stock. It is easy to understand why this happens. For instance, when we buy a slice of cake, it is based on the price of the slice, we might not think of calculating how much we are paying for the entire cake. We start comparing slices of one cake with another without looking at its different weight and the per kg value of each cake. That may be OK with cakes but not with equity shares.

The best example to explain the this is to compare market value and market price of Visa & Master Card.

Market Value of Master Card as on December 2017:

US$ 179.47 a share price X 1040 million shares = US$ 186.65 billion

Market Value of Visa as on December 2017:

US$ 118.94 a share price X 2353 million shares = US$ 279.88 billion

Comparing Visa & Master Card by price per share, we might feel that at almost US$ 180 per share, Master Card is a bigger company than Visa at US$ 119 per share. But when we compare the market value of equity, it is clear that Visa is a bigger company. Visa is bigger than Master Card in terms of its market capitalization. It’s possible that Master Card may be bigger in terms of its brand name, no. of subscribers, etc.

Reference

BOOKS:

  • Analysis of Financial Statements – Leopold A. Bernstein & John J. Wild, Fifth Edition
  • Equity Analysis & Valuation – CFA level-1 2012, CFA Institute USA
  • Fundamental Analysis for Dummies – Matt Krantz
Last updated on : April 21st, 2018
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