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What is Market Value?
Market value of shares is a price at which respective securities are traded in a stock exchange. It is essentially the price at which you can purchase or sell any share or bond in the stock market.
Stock market value is heavily dependent upon the market demand for such shares, which, in turn, is determined by the overall performance and growth potential of a company. The market value of all equity shares issued by a company is taken into account it’s determining the market capitalisation, which reflects a relative size of business.
Market capitalisation of a business is calculated by multiplying the market value of its shares with a total number of outstanding shares circulating in the market. Organisations having market cap higher than Rs. 20,000 crore is considered to be a large-cap company, while market capitalisation ranging between Rs. 5,000 crore and Rs. 20,000 crore is categorised as mid-cap companies. Furthermore, companies with a market cap lower than Rs. 5,000 crore can be labelled as small-cap companies.
The market capitalisation value reflects the risk-return ratio associated with an investment. While large-cap companies are considered to have significant financial backing to tackle any economic turmoil arising both internally and in the global market, stocks of small and mid-cap companies are regarded as capital appreciation tools.
As small and mid-cap companies have significant potential for growth, the stock price and thereby market value of equity of the same can rise substantially over time, even more so during times of economic boom. On the other hand, large-cap companies often demonstrate a stable and relatively lower rate of growth in their share prices, which is compensated through periodic dividend pay-outs.
Book Value vs Market Value
Book value of a company is significantly different from its stock market value. While the market value of shares represents a maximum amount investors are willing to pay for ownership of one unit of the company, book value is how much investors can gain as returns if the respective company liquidated its assets respective to the percentage of ownership earned through the shares.
Book value of stocks provides a comprehensive idea about the return on investment undertaken by an individual based on the market value of shares. In the event of bankruptcy, equity shareholders are paid back, at last, hence, have the relatively low chances of realising high ROI, as such a situation indicates internal financial turmoil.
Analysing the book value of a company and dividing it by the number of outstanding shares can help individuals gauge the security of their investment corpus, thereby mitigating the risk factor substantially.
Market Value vs Face Value
Market value of a share is often confused with another popular term called face value.
While market value is the present value at which the stock is trading, it is often confused with the face value. The face value ,also commonly known as par value of a stock is the value of a company as per the books and share certificate. Simply put, stocks are nothing but ownership contracts. The face value of the stock is its original value when funds are raised by the company. This value is determined and decided upon by the company when the time of issuance of shares comes. Let’s understand this with an example,
Suppose you buy the share of a company A at a market price of Rs 200, with a face value of Rs 10. This essentially means that your contribution is of Rs 10 in return of a share in the equity of the business. The remaining 190 Rs is contributed to the company’s profit. The only way a company will make a profit is when it sells its shares at a premium which is the market value , above the base price or actual value of the share which is the face value.
Unlike market value, the face value is fixed – not bound by market conditions and is only affected in proportion to the stock split ratio. It is generally below the market value but may be equal or higher to it in case of penny stocks. One can arrive at the equity share capital by multiplying the face value by the total number of shares.
Market Value and a Value Trap
While a market value reflects the perception of the public regarding the performance of a company in the market, it does not necessarily indicate its true potential. Often individuals consider a listed organisation to perform well if it has low evaluation metrics, such as price to earnings ratio and price to cash flow ratio. Such metrics often indicate that a share is undervalued in the market, thereby leading individuals to believe that investing in the shares of such companies would help them realise capital gains in future.
However, such low financial ratios can also reflect high degree systematic risks associated with the management of the company. Hence, if the intrinsic values of such companies are not thoroughly analysed, investors can incur hefty losses if the productivity of the business falls further.
Importance of Market Value
Basic market value of shares indicates the amount individuals are willing to pay for such securities to a corresponding seller in a stock exchange. High market value is often correlated with a substantial demand for a stock in the market, as investors are optimistic about its future performance.
The supply of respective shares is low as well, as individuals holding such shares are reluctant to sell it in fear of losing out on capital gains through a rise in stock prices in the future.
Limitations of Market Value
As stated above, just looking into the stock market value is not sufficient while choosing shares for your investment portfolio, as investors run the risk of falling into a value trap. It only takes account market fluctuations and its corresponding effect on the share prices.
Any systematic risks associated with an investment cannot be identified through such tools, and hence, requires an in-depth analysis of other intrinsic value tools such as price to earnings ratio, discounted cash flow, etc.