Market value

economic-dictionary

Market value is a concept closely related to financial markets. It refers to the value of a certain asset, which is established based on market participants and the law of supply and demand.

Market value, as expressed in the technical definition, is a concept widely used by economists who are employed in investment firms, or linked to financial markets. When they speak of market value, they are referring to the value of a certain asset in the market. A value that, as its name suggests, is established based on the participants in that market, as well as the interaction between supply and demand.

In the same way, economists, while not engaging in financial markets, also speak of market value to refer to goods and services. As in financial markets, value is also established through the interaction between supply and demand. For this reason, the market value of a good or a certain service is the amount that a buyer is willing to pay for acquiring said good, or the desired service.

As we will see below, the market value has a series of characteristics that should be noted, and that we must know.

Market value characteristics

As we said before, market value is a widely used concept in economics. Therefore, it is convenient that we know some of the following characteristics, which must be taken into account if we want to understand this concept well:

  • Market value is a concept only present in market economies.
  • That is, for it to exist, there must be buyers and sellers that interact in an open (free) market. This is because the market value is established by the interaction between supply and demand.
  • Unlike the accounting, it is subjective, since we cannot know the real value, but the value that the participants are willing to pay.
  • It is not fixed, as it fluctuates depending on the participation of these individuals in the market.
  • It is a concept closely related to financial markets, although it can also refer to a market for goods or services.

Market value formula

As usual, the market value, especially in financial markets, is obtained through a simple formula that we will see below.

This formula has been widely used by economists, as well as countless investment firms, to know the market value of these assets.

Thus, it is often said that the market value of a company refers to the market capitalization that, at the moment, that company presents. In this way, to know the market value of this company, we must multiply the number of shares that are in circulation by the price per share that this asset presents at that time. In this way, we will obtain the market value of that company.

The formula cited above would be the following:

Market value = No. of shares in circulation x Price per share in the market

With this formula, and seeing its book value, we can observe the difference and see if a company is better or worse valued by the market, and this, with respect to its book value.

Difference between market value and book value

To know the usefulness of the market value, it is necessary to know, in the same way, what is the book value of a company.

And it is that, unlike the market value, the book value of a company we could say that it presents a greater objectivity. This is because the book value is not extracted from the perception that an investor has and the amount that he is willing to pay for the company, but by the book value of the assets that the company owns, once we have subtracted its liability .

In this way, knowing the book value and the market value, and observing the difference between the two, we can tell if a company is more or less overvalued or undervalued by the market. This, given that if a company has a very high market value compared to its book value, there are no objective criteria to say that the company has that value. For this reason, we say that market value is subjective.

Market value advantages and disadvantages

Among the advantages and disadvantages of this indicator, we must highlight an advantage and a disadvantage.

First, the advantage of this indicator is that it allows us to know the difference between it and the company's book value. In this way, using these two indicators simultaneously, we can know if a company is more or less overvalued, or undervalued, in the market. This, when observing the difference between both values.

On the other hand, with regard to its main disadvantage, it should be noted that we are talking about the subjectivity presented by this indicator. That is, the market value does not reflect the value of a certain share, but rather what a buyer is willing to pay for that share, after participating in a market and supply and demand interact. That subjectivity could lead us to pay more than we owe for the action.

For this reason, it is convenient that, as can be seen in the advantage that we have indicated, this indicator is used in addition to others, such as the book value.

Market value example

To finish, let's see an example of how the market value is calculated and how we can use it, complementing it with the book value.

So let's imagine a company listed on the S&P 500 with a value per share of $ 5. In the same way, the number of shares outstanding is 1 million. Therefore, its market capitalization, or the market value of that company, is as follows:

1,000,000 x 5 = $ 5,000,000

By doing the calculation, we get that the market value is 5 million dollars.

Now, looking at the book value, we see that the company, once we have valued the assets and subtracted the liabilities, has a book value of $ 3.2 million.

Observing this difference, we will say that the company is overvalued in the market, by showing a market value higher than the book value that corresponds to it after valuing its assets and liabilities, and making the difference.

As we can see, we can use both indicators to make a more extensive analysis of the company, while reducing the possibility of paying a higher price than book value.

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