The Market Value of Equity of the company, also known as Market Capitalization, is the total monetary value of the firm’s equity.
We calculate it as the current stock price multiplied by the number of outstanding shares. Therefore the MVE continually changes, as these two values are quite volatile.
Analysts mostly use the Market Value of Equity as a basis to calculate performance ratios. Investors use it to evaluate the size of companies and diversify their portfolio across investments of different sizes and risk-levels.
Market Value of Equity (MVE)
The measure represents the total value of a company in the eyes of the investors. MVE can shift a lot during times, at which important information about the company becomes publicly available.
More substantial enterprises usually have more stable market values, while smaller businesses can experience more significant changes in market capitalization due to the relatively small number of transactions. This makes smaller companies a potential target for market manipulation.
The Market Value of Equity represents how much investors believe a company is worth at the current moment.
How to calculate MVE
The Market Value of Equity shows us the total value a business has received from its investors. Therefore, when we calculate the measure, we consider all shares, both common and preferred stock.
Factors Affecting the Market Value of Equity
When more participants are active on the market, it becomes more efficient. In the long run, this ensures that market price reflects the actual value, which brings the market value closer to the intrinsic value of the business.
Another factor with a substantial effect on market price is the extent to which new information about the business becomes available.
Market cycles like recessions and booms also affect the MVE, as they have an impact on investor behavior.
Issues With the Calculation
When we perform a Market Value of Equity calculation and analysis, we need to keep in mind the following issues that may arise.
Usually, only a small portion of the shares of a public company are actively traded. This results in minor deals being able to have a significant influence on the valuation.
It is challenging to determine the market price for the shares of a privately-held company.
At some points in time, different industries might become more appealing to investors. Thus an enterprise’s share price might suffer fluctuations that are not entirely representative of the business’ performance.
Upon acquiring a controlling share in a company, investors need to take into account the transfer of control from the previous owners. The cost of power is the premium in an acquisition deal, and it is normal for it to be north of 20%.
Difference between Market Value and Book Value of Equity
We calculate the BV of Equity based on the shareholder equity in the Balance Sheet. It focuses on the own assets and owed liabilities of the company, as we arrive at it as a difference between the two.
The Book Value of Equity can be positive, negative, or equal to zero. On the other hand, Equity’s Market Value is usually higher than the Equity’s Book Value, as the value of an enterprise appreciates over time. It also cannot be negative or equal to zero, as we calculate it as market price multiplied by the number of outstanding shares.
Therefore, we suppose the Market Value of Equity also prices in some of the growth we expect the firm to achieve.
Difference between MVE and Enterprise Value
The Enterprise Value (EV) of an entity incorporates the Market Value of Equity, along with Debt and less Cash. The measure gives a rough idea of the takeover value of a company.
We subtract the Debt, Non-Controlling Interest, and Preferred Stock, as these represent the holding of other shareholders. We add Cash and cash equivalents back, as any monetary value left is attributable to the equity holders.
It is essential to understand the distinction between Enterprise Value and MVE. Equity Value is the total value of the business, which is available only to investors in equity. At the same time, EV is the value of the core business activity of the firm, which is accessible for all shareholders.
You can also reverse the above formula to calculate the Enterprise Value:
Based on their liquidity, and the judgment of the analyst, short-term and long-term investments might also be subtracted.
Another significant difference between Enterprise Value and MVE is the discount rate we use. The calculation of Equity Value uses levered free cash flows (available to equity investors). We use the Cost of Equity as a discount factor because the measure only looks at what’s left for the equity investors. On the other hand, the EV calculation uses unlevered free cash flows (available to all shareholders). Therefore, we use the Weighted Average Cost of Capital (WACC) when performing the EV calculation because it considers all investors.
Market Value of Equity and Company Market Profile
Analysts use the MVE to separate companies into three levels of market capitalization.
- $0 to $2 billion – Small Caps;
- $2 to $10 billion – Mid-caps;
- Above $10 billion – Large Caps.
Each level has specific characteristics that can help investors understand better the behavior of the company.
Small Caps, on the other hand, are generally young companies in the growth stage of their development. These bring higher potential returns, which are associated with higher risk. Large Caps are mature enterprises with fewer options for growth. However, these tend to be more stable in their market performance. And Mid-caps are a hybrid between the two.
Investors use the levels to diversify their portfolios by holding stocks in each size category.
The Market Value of Equity is the evaluation of a company by the stock market. This is because the market price is dependent on the confidence of the potential shareholders in the business. Investors wouldn’t put their capital in an enterprise, which is they don’t expect to grow over time.
MVE is the starting point of any performance ratios analysis. Analysts use it to categorize the company, and calculate a variety of metrics like Price to Earnings, Price to Book Value, and Enterprise Value to EBITDA. Therefore, it’s essential to properly understand what the Market Value of Equity is and how to calculate it.
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