What is Equity Value?
Equity Value, also known as market capitalization, is the sum-total of the values the shareholders have made available for the business and can be calculated by multiplying the market value per share by the total number of shares outstanding. It is very important for a business owner especially when he plans out to sell his business as it gives a good measure of what a seller of business would receive after the debt has been paid.
Let us have a look at the above graph of Equity Market Value of Exxon, Apple and Amazon. We note that in 2007-08, Exxon was far ahead in terms of market value compared to Amazon and Apple. However, over the years, Apple and Amazon’s market value has catapulted and now they are leading companies. Does it even matter?
In this article, we will talk about the following –
Equity Value Formula
There are two ways in which you can calculate Market Value of Equity
Formula #1 –
Equity Value = Share Price x Number of Oustanding Shares
- Share price is the last traded price of the stock
- Number of Oustanding shares should be the latest figures available
Formula #2 –
This second equity market value formula is commonly used to find the “fair equity value” (using DCF Approach)
We use the following steps to calculate the fair equity market value –
- Use Discounted Cash Flow approach using FCFF to find the Enterprise value of the firm. DCF will provide us the fair valuation of the total firm (Enterprise value)
- Use the formula, Enterprise Value (calculated using DCF) = Fair Equity Value + Preferred Shares + Minority Interest + Outstanding Debt – Cash & Bank balances
- With this, we can calculate Fair Equity Value = Enterprise Value – Preferred Shares – Minority Interest – Outstanding Debt + Cash & Bank Balances
Target Price of the stock = Fair Equity Value / Number of Oustanding Shares
Please note that Market Price of stock and Target Price of stock are two different things.
Let us assume that Market Price of Apple is $110 per share. Using DCF, you may get a target price of Apple stock as $135 per share. This means that Apple is undervalued and should reach the target of $135 per share in the near future.
Equity value is more useful to the seller of a business than an investor. Let’s have a detailed look at this.
Let’s say that Mr A has a company which he wants to sell. Now he is concerned about the valuation of the company. One day, while searching for buyers of his business, Mr A got a proposal from Mr B. Mr B said that he would buy Mr A’s business at a certain valuation. Mr A went back home and thought about the valuation Mr B gave. Mr A mentioned that he has taken some loan for his business which has not been fully paid yet. Mr B said that then he would pay the same as the valuation he has calculated; however, Mr A will only receive the money after payment of debt. And that’s “market value of equity” in the actual sense.
Now let’s understand it in numbers. Mr B said he would pay US $10 million for Mr A’s business before knowing that Mr A has still to pay some debt. Mr A mentioned that the outstanding debt is US $2 million. Then Mr B agreed to pay Mr A, US $10 million for the business but that would be inclusive of the outstanding debt. That means Mr A would only get US $8 million. Here the US $10 million is the enterprise value and US $8 million is the equity market value.
Equity Value Example
Let us do a basic example of comparing two companies on the basis of market value and finding the larger one. Here are the details of Company A and Company B –
|In US $||Company A||Company B|
|Market Price of Shares||100||90|
In this case, we have been given both the numbers of outstanding shares and the market price of shares. Let’s calculate equity market value of Company A and Company B.
|In US $||Company A||Company B|
|Outstanding Shares (A)||30000||50000|
|Market Price of Shares (B)||100||90|
|Market Value (A*B)||3,000,000||4,500,000|
We note that the market value of Company A is more than the market value of Company B. But let’s tweak few things and calculate Enterprise Value and let’s see how it turns out for investors.
Equity Value Calculation
Please have a look at the table below.
- Column 1 contains the number of outstanding shares.
- column 2 is the current market price.
- Column 3 is the Equity Value calculation = Shares Outstanding (1) x Price (2)
If you want to calculate the Market Value of Facebook, it is simply the outstanding number of shares (2.872 billion) x Price ($123.18) = $353.73 billion
In the final analysis, it can be said that equity value is the best method if the owner of a business wants to know how much he would get by selling his business. From the investors’ point of view, enterprise value will fit the bill.
Equity Value Video
This has been a guide to what is Equity value and its definition. Here we discuss examples of the equity value of a firm along with its interpretations and how it is useful to sellers. You may also look at the following articles to learn more about valuations –