One of the most important tools that investors use to decide whether to buy or sell a security is its market value. It is often different from a security’s market price, though sometimes market value and market price coincide. Here is a description of what affects market value and why it’s important to consider when you make investing decisions.
What is Market Value?
Market value or open market valuation, also known as OMV, is the price that would be paid for an asset in an open and competitive market where buyer and seller have adequate information, are not under any compulsion and mutually agree on the price.
It differs from an asset’s market price, which is simply the price that a security actually trades for at any given time. Over the short term, value and price often differ, but over the long term they are more likely to coincide.
Factors That Can Influence Market Value
The OMV of a security is based on numerous factors that analysts and savvy investors spend considerable time considering. Generally, those factors fall into one of three main categories: various metrics on the company’s performance; the ratios of some of those metrics to the company’s share price; and broad economic trends.
Firstly, a company’s return on equity, its sales volume, market share and earnings all figure into a calculation of market value. Other influences on market value are a company’s long-term potential, debt-to-equity ratio and its assets and liabilities.
Earnings also figure into market value estimates. A company may report quarterly or annual earnings that exceed what analysts expected. For instance, if a company predicts it will earn 5 cents per share and then it earns 15 cents per share, the market value of its shares is likely to rise. Of course, the opposite is true, too. The consistency of earnings also matters. If a company regularly issues good earning reports, despite the economic conditions, it attracts investors.
Secondly, the ratio of the share price to earnings, either past or projected, and the price-to-sales ratio should be part of any market valuation.
Thirdly, business valuation is often affected by the economic picture as well. When there is a market downturn or the economy is facing a recession, it’s often more challenging for companies to earn a profit. Therefore, their growth rates may decline during this time, which may decrease the demand for stocks. What the Federal Open Market Committee does with interest rates also affects market value. For example, the lower the cost of money, the stronger a company’s outlook is.
Often, calculating the market value of securities, like stocks and futures, is easier than
calculating the market value of an over-the-counter security such as some fixed income securities. This is because traded assets like stocks are broadly circulated and highly liquid. This makes the prices readily available for investors. Calculating the market value for assets, like businesses or real estate, is even more challenging. This is because there are a lot of factors involved. But no matter what asset you’re reviewing, conducting a market valuation is a necessity.
Why Market Value is Important to Investors
These data are useful when comparing stocks in the same sector to one another. Using all these data points can help an investor discover and seize potential buying and selling opportunities.
In regard to stocks, understanding market value is essential for knowing when an investor should buy or sell shares. It can indicate to investors if a stock is affordable. It also advises if a stock is possibly over-priced. However, basing investment decisions on market value alone may prevent investors from capitalizing on buying or selling opportunities. This will result in missing investments that could be beneficial to their portfolios.
The Bottom Line
There are many different factors that can impact the market value of an asset. Three of the main ones are metrics on the company’s performance; the ratios of some of those metrics to the company’s share price; and economic conditions and trends. So, if a certain security interests you, make sure to conduct a full evaluation of that security before making your final investment decision.
- Consider talking to a financial advisor about the market value of any securities you’re considering trading. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be match with local advisors who will help you achieve your financial goals, get started now.
- If you’ve only got a little money to invest in the market, you may be better off working with a robo-advisor. These investing services will determine your ideal asset allocation and then build you an investment plan, without the need for the minimum investments required by traditional advisors.
Photo credit: ©iStock.com/anyaberkut, ©iStock.com/D-Keine, ©iStock.com/narvikk