When evaluating a publicly traded company and deciding whether to buy some of its shares, you should not focus solely on one share price. Be sure to look at its market capitalization or “market value” to get a clearer picture of how the market values the company.
Market capitalization represents the amount you would pay to purchase all of the company’s shares, but not necessarily its true value. The size of the company’s market value determines the general category of publicly traded companies – small-cap, mid-cap, or large-cap.
Learn what market value can tell you about a company and why you should use it when evaluating the business.
What is Market Value?
Market capitalization is the number of outstanding shares multiplied by the current share price. The result tells you the value of the company’s shares in the stock market. It is calculated using the drift method or the free cash flow method.
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The required amount is the number of shares held by the investing public and is calculated in the stock market, whereas the free cash flow method does not consider shares held by executives, government, or other private parties of shareholders whose stock is not traded in the market.
> Typically, stock market indices use freely flowing market capitalizations. The Dow Jones Industrial Average and the Standard & Poor’s 500 are examples.
Market Value Systems
When assessing companies, market value helps you compare similar companies. The criteria for small-cap, mid-cap, and large-cap companies differ. Valuation also changes with the general market volatility. Here is an ideal system:
Small-cap companies: Less than $1 billion
Mid-cap companies: $1 billion to $10 billion
Large-cap companies: $10 billion or more
On June 3, 2021, Standard & Poor’s began using these thresholds and ranges for its large, mid, and small-cap indices.
S&P 500 Fund: At least $13.1 billion
S&P MidCap 400 Fund: Between $3.6 billion and $13.1 billion
S&P SmallCap 600 Fund: Between $850 million and $3.6 billion
Some companies and analysts add micro-cap and mega-cap – the smallest and largest publicly traded companies overall – to the mix.
In general, small-cap stocks tend to have a higher chance of price growth, as the companies themselves still have growth potential. However, these investments can be riskier, as future performance is not always known.
Large-cap stocks have lower growth potential but are considered safer investments due to their longer track records of success. Mid-cap stocks usually stand between small-cap and large-cap stocks in terms of growth timeframe and safety guidelines.
Market Value vs. Book Value
The market value of a company can also be referred to as the “fair value of equity.” Market value only considers the value of its common stock. Book value is a broader way to measure a company’s value.
To calculate the enterprise value of the business, you add the market value to the value of its preferred stock (if any) plus any minority interest in the company (if any). Then add its debt and subtract its cash and expected liquidity bonuses.
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Cash and bonuses are deducted from market value because if you were to buy the company, you would take this money. Therefore, they should not be included when arriving at a theoretical acquisition price for the company.
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To use the book value instead of the market value in common metrics for evaluating companies. Some examples include the enterprise value to EBITDA or the enterprise value to revenue. This can help in determining the value of companies with significant cash flow impacts.
Frequently Asked Questions
Why is market value important?
Market value represents the total value of a company in the open market. It indicates how much it is worth to investors. It gives you an idea of the size of the company, its operations, and the resources available to it. These factors help you assess the potential risks and the returns associated with investing in the company.
How does market value affect share price?
Market value and share price are essentially two ways of expressing the same information. Any change in one will be reflected immediately in the other. You can think of market value as the total number of outstanding shares multiplied by its share price. You can also think of the share price as the market value divided by the total number of outstanding shares.
Alans does not necessarily provide tax, investment, or financial advisory services. The information is presented without regard to the investment objectives, risk tolerance, or financial circumstances of any specific investor and may not be suitable for all investors. Past performance is not indicative of future results. Investing involves risks, including the loss of principal.
Source: https://www.thebalancemoney.com/why-per-share-price-is-not-important-3140791
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