Equity Value

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 the 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?

Top-Market-Capitalization

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

  • The share price is the last traded price of the stock
  • The 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)

Enterprise Value Vs Equity Value Diagram

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For eg:
Source: Equity Value (wallstreetmojo.com)

We use the following steps to calculate the fair equity market value –

  1. Use the DCFDCFDiscounted cash flow analysis is a method of analyzing the present value of a company, investment, or cash flow by adjusting future cash flows to the time value of money. This analysis assesses the present fair value of assets, projects, or companies by taking into account many factors such as inflation, risk, and cost of capital, as well as analyzing the company's future performance.read more approach using FCFF to find the Enterprise valueFind The Enterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover.read more of the firm. DCF will provide us the fair valuation of the total firm (Enterprise value)
  2. Use the formula, Enterprise ValueEnterprise ValueEnterprise Value is a measure of a company's total value that spans the entire market rather than just the equity value. It includes all debt and equity-based ownership claims. This value, which is calculated as the market value of debt + market value of equity - cash and cash equivalents, is particularly relevant when valuing a takeover.read more (calculated using DCF) = Fair Equity Value + Preferred Shares + Minority Interest + Outstanding Debt – Cash & Bank balances
  3. With this, we can calculate Fair Equity Value = Enterprise Value – Preferred SharesMinority InterestMinority InterestMinority interest is the investors' stakeholding that is less than 50% of the existing shares or the voting rights in the company. The minority shareholders do not have control over the company through their voting rights, thereby having a meagre role in the corporate decision-making.read more – Outstanding Debt + Cash & Bank Balances

Target Price of the stock = Fair Equity Value / Number of Oustanding Shares

Please note that the Market Price of stock and Target Price of stock are two different things.

Let us assume that the Market Price of Apple is $110 per share. Using DCF, you may get a target priceTarget PricePrice Target in the context of stock markets, means the expected valuation of a stock in the coming future and the valuation may be done either by the stock analysts or by the investors themselves. For an investor, price target reflects the price at which he will be willing to buy or sell the stock at a particular period of time or mark an exit from their current position.read more 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.

Interpretation

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 loans 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 the 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 the 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 the 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 the US $8 million. Here the US $10 million is the enterprise value and the US $8 million in 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 ACompany B
Outstanding Shares3000050000
Market Price of Shares10090

In this case, we have been given both the numbers of outstanding shares and the market price of shares. Let’s calculate the equity market value of Company A and Company B.

In US $Company ACompany B
Outstanding Shares (A)3000050000
Market Price of Shares (B)10090
Market Value (A*B)3,000,0004,500,000

We note that the market value of Company A is more than the market value of Company B. But let’s tweak a 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.

Equtiy value calculation

source: ycharts

  • 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.

Conclusion

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

 

Recommended Articles

This article 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 –

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