Market Value and Valuation Methods
- The market value of a stock is simply the price the market is willing to pay for that stock. For example, a stock trading on the New York Stock Exchange at $55 per share and has a market value of $55 per share. If there are 1,000,000 outstanding shares of that company's stock, the market value of equity for the entire company is $55,000,000.
- One of the most common valuation methods for stocks is to calculate the net present value of future cash flows. Because a dollar today is worth more than a dollar tomorrow, future cash flows must be discounted to be evaluated in terms of present dollars. Obviously, future cash flows cannot be known with any certainty, so they must be estimated by investors based on their evaluation of the company and the future market.
- Return on Invested Capital, or ROIC, measures the financial return realized by the financial capital invested in the company. This capital can be in the form of debt or shareholder equity. To calculate this ratio, simply divide the company's net income by the total invested capital. A company with a high ROIC will be more valuable because its managers are more adept at using available funds to turn a profit.
- The Return on Equity is similar to the Return on Invested Capital except that it measures the return on only the capital contributed by shareholders. Because this measurement more closely follows the success with which shareholder contributions are invested, it more accurately measures the value of the equity in the company.
