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Finance and capital markets
Course: Finance and capital markets > Unit 6
Lesson 3: Understanding company statements and capital structureMarket capitalization
Market versus book value of equity. Created by Sal Khan.
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Sal perhaps it would help if you could explian why the market would value Jasons equity at 3.42 time book value as compared to Bens at 1.59 times book value. Your videos are great. I am a banker and on most days I spent 30/45 minutes every morning listening to them. Keep up the good work.(10 votes)- You should watch the next video and you will get a better understanding. The reason why investors will value one company more times "book value" than another is because of the intangible assets, i.e. one company has a brand name that will earn it a lot more future profits than the other and will make the company worth more, so now investors are willing to pay more money for the stock.(8 votes)
- How is price of stock determined here?(8 votes)
Whenever a stock is sold, the exchange records the price at which the stock changes hands. If, a few seconds or minutes later, another trade takes place, the price at which that trade is made becomes the new market price, and so on.(5 votes)
Does the ratio between the Market Cap and the Book Value have a name in the financial industry?(6 votes)- P/B or Price to Book, but most people use Price to tangible book. Remember, you cannot "make payroll" with intangible assets like goodwill.(5 votes)
- When a company sells bonds they put that income into their assets and can use that money in the company. Does it work the same with stock? Like for example Walgreen's book value is much less than the market value. Does a company use money from stock in their company like they do with bonds? Does a company use the profit from the difference in book and market value( P/B )( when market value is much higher) as assets or money? Or is it just equity only but they can't use it as money?(3 votes)
If a company sells a bond, they will use the money however they see fit. The company hopes that that money will enable them to make enough money to pay insterest to the bond owner, and let them redeem the bond when it reaches maturity a few years after it was bought. The money will also hopefully grow the company so that at the end of the day, both the person who bought the bond and the company have more money.
When a company sells a stock, they are essentially giving partial ownership of the company to the stockholder. In most cases, stockholders can influence company descisions through shareholder meetings, etc.
The company makes money from the share being sold from the company itself to a shareholder. However, after the first time a share is sold, the company usually doesn't directly make money on it because it is sold only between third parties like day traders and stock exchanges.
Companies can still arguably make money off their stocks after the intial sale, though. If the stock price is going up, it indicates that the company is healthy and it will draw in investors and customers.
Hope this helps!(5 votes)
- Most of the time i calculate & see the market cap is much greater than the book value..what does it mean? does market most of the time overvalue a share or else..the balance sheet is public..after the assessment why people buy a stock multiple of its real value in the book??(2 votes)
Look at it as though you're buying the whole business (that's what Warren Buffett does!) If you paid $215,000 for Ben's shoes, assuming business didn't get any worse or better, you would make $21,450/year (nearly a 10% return). If instead you put that money in a savings account - if you're lucky you'd get $2000/year. So people take on the risk of owning the business, in order to reap the rewards of more money. Even if you bought the company for $400,000, ($40/share) you'd still be doing better than in a savings account. But you have to think if it's worth the risk of possibly losing your money. (which isn't an issue with the savings account)(4 votes)
- Does the market ever value a company for less than the book value?(2 votes)
- The market can value a company for much less, or much more than book value, although the latter is more common than the former. An electric utility with a bunch of coal-fired plants might have a book value of $10B, but if the market thinks that the government is about to ban coal-burning, it might only value the company at $5B. Conversely, if I buy the domain name "waabu.com" for $7.00 and start a social media company in my basement with a book value of $50,000 the market could value the company at $100M if they think it has potential (or it's in a dot-com frenzy).(3 votes)
I have seen in stock market for some companies the book value is negative ? How is that possible ?(2 votes)
Value of liabilities exceeds book value of assets.(2 votes)
- How does the market decide how much any company is worth. For instance, how would the market decide the Ben's stocker price is $21.50? Would it have access to the income statement and the balance sheet? Thanks!(2 votes)
- Yes, many investors, particularly professionals, study financial reports and other data to decide which stocks they think are underpriced, and then they buy those.(1 vote)
- who decides the price of the share and number of shares to be issued?(2 votes)
Does short selling affect Market cap? I'm wondering this since short selling essentially puts extra shares on the market.(1 vote)
Short selling does not affect market cap. Short selling, in fact, does not actually add shares to the market. The short seller gained one share, but it also received the liability to pay all the costs that come with that share. For instance, if the company decides to dividend out some money, the brokerage won't be able to get any money from the company for the share it loaned out. Instead, the short seller will have to pay the amount of the dividend to the brokerage. So you can think of the short seller as having -1 shares, which will end up balancing everything out.(3 votes)
Video transcript
Let's say that both Ben's
Shoes and Jason's Shoes are publicly traded companies. And all that means is
that both of their shares are traded on exchanges. Maybe it's the NASDAQ, or
the New York Stock Exchange, or some other exchange. And the going price
on those exchanges-- the last closing price for Ben's
stock was $21.50 per share, and the last closing price for
Jason's stock is $12.00 per share. What I want to
explore in this video, and probably the
next few is, what is that saying for
what the market thinks these businesses are worth? So in both of these situations,
they have 10,000 shares. And remember, the shares are
a split of the owner's equity. It's not a split of the assets. It's a split of just the
equity part, right over here. So if shareholders are
willing to pay 21.50 per share for Ben's stock, and there are
10,000 shares in Ben's company. So you take 21.50 times--
I'll do it this way-- times 10,000 shares
gives us a market cap. So 21.50 times 10,000
gives us $215,000. And what this says is, look,
if each of those 10,000 slices of the equity is worth 21.50,
then the entire equity portion is going to be-- the market
is valuing it at $215,000. And this calculation,
this multiplication of the market price per share
times the number of shares, this is called the market cap. Short for market capitalization. The market cap of the company. And all it is, is
what is the market valuing the equity part
of Ben's company worth? Let's do the same thing
for Jason's company. You have $12.00 per share
times 10,000 shares. That gives us
$120,000 market cap. So the market is telling us
that even though on the books, Ben's equity-- based on
how he valued his assets and his liabilities--
is 135,000. The market is actually
valuing this at 215,000. And in the next
video, we'll think about what that means for
how the market is actually valuing the business. In the case of Jason's business,
instead of $35,000 of equity-- just straight up from
what's on the books-- the market is valuing this
piece right here at $120,000. So hopefully that gives
you a little sense of one, what shares
are a share of. They're a share of the owner's
equity, not of the assets. And also gives you a good
sense of what market cap is. It's the market's value
of the owner's equity. And notice, in both
cases-- and it's usually the case--
it's going to be a different number than the
book value, the number that's actually on the books.