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Market capitalization

Market versus book value of equity. Created by Sal Khan.

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  • blobby green style avatar for user jamalontario
    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)
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    • blobby green style avatar for user adlosh
      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)
  • blobby green style avatar for user Lakshmi Anna
    How is price of stock determined here?
    (8 votes)
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  • sneak peak green style avatar for user Ryan Nee
    Does the ratio between the Market Cap and the Book Value have a name in the financial industry?
    (6 votes)
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  • blobby green style avatar for user Vee Vald
    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)
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    • purple pi purple style avatar for user Jousboxx
      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!
      (6 votes)
  • blobby green style avatar for user Abdullah Nur Ovi
    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)
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    • old spice man green style avatar for user TerryMHogan
      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)
      (5 votes)
  • blobby green style avatar for user alli sabo
    Does the market ever value a company for less than the book value?
    (2 votes)
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    • old spice man green style avatar for user TerryMHogan
      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)
  • piceratops seed style avatar for user Rahul Parashar
    I have seen in stock market for some companies the book value is negative ? How is that possible ?
    (2 votes)
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  • leaf green style avatar for user arjunbendre
    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)
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  • blobby green style avatar for user Anish Dhopeshwarkar
    who decides the price of the share and number of shares to be issued?
    (2 votes)
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  • orange juice squid orange style avatar for user Jason Else
    Does short selling affect Market cap? I'm wondering this since short selling essentially puts extra shares on the market.
    (1 vote)
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    • ohnoes default style avatar for user Tejas
      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.