How do you determine the value of a company? Share price is one common way that we assign value to a company. It’s a good guide and starting point. But does the share price reflect the company’s true value? Not necessarily. It’s just a bit more complicated than that. Most of the complication comes from the fact that share price is based not just on the company’s current value but also anticipation of its future value. So, what is the real what that you can determine a company’s true value?
What Is Share Price?
The share price is also called the stock price of a company. It is a number that tells you what it costs to buy one share in the company on the stock market. As you likely know from basic investing, the share price changes all of the time. Any time that a stock is sold, the new price is the market price of the stock. This can go up and down with each sale.
There are many factors that affect the share price. Does the share price reflect the company’s true value? It is a partial reflection, but it’s not the whole story. That’s important to understand when making investments.
Who Decides Share Price?
The market decides share price. It’s all about the fundamental essence of economy: supply and demand. For each company, share prices began at the time of the IPO. The market’s demand for the company’s stocks, weighed against the perceived supply of those stocks, determines the basic share price at IPO.
After that, supply and demand may fluctuate for all kinds of different reasons. For example, a scandal related to a company might affect how much demand there is, changing the share price. If the company makes more shares available on the market, therefore increasing supply, then this also affects the stock price.
What Is A Company’s True Value?
The share price is one key way that people, specifically investors, measure a company’s true value. However, that’s not what really what the true value of a company is. It’s just the market value of the company. A company’s true value, also called its intrinsic value, which looks at the future of the company rather than just the present market share. In other words, it takes a long view of the company’s worth. While it values the present stock value and the daily changes in supply and demand, it also takes additional factors into consideration to assess what the company is worth now and likely worth in the future.
How to Calculate A Company’s True Value
Strategy+Business explains that there are many different models that businesses use in order to assess a company’s true value, “but all of them estimate the value of a company at a particular date on the basis of expectations about future cash flows.” So, they set a date in the future, they look at information from today including share price, and then they make an educated guess about what the company will be worth on the date. This allows for those steady changes in the market attributed to both controllable and non-controllable factors without changing the value of the company itself from day to day.
Relationship Between Share Price and A Company’s True Value
In short, then, share price is not a reflection of a company’s true value. Rather, it is a factor that goes into assessing the intrinsic value of the company. This number is combined with other factors to get that true value. So, it’s important. It’s a clue. It’s a variable in the equation. But share price alone doesn’t reflect a company’s intrinsic worth.
Strategy+Business argues that there are three fundamental questions that a business should review when determining their own intrinsic value. The first of these looks at the expectations that investors have about your value which are reflected in the share price. Again, this makes share price a clue and a key factor in determining value. They define share price as indicating crowd wisdom. This is the amount that investors see your company as worth right now, with some, but limited, anticipation of future supply and demand.
This can be seen as setting the bar for the baseline that you need to meet as a company in order to maintain existing share price. This is what people expect from you. If you can exceed it, then you can increase the intrinsic value of your company.
When Company Value Rises, So Does Share Price
Over time, as you increase the intrinsic value of the company by exceeding those expectations, your share price will also rise. Your investors thought you would do X amount well and based their selling and buying prices on that. However, as you show them that you can actually consistently do Y amount well, they eventually adjust their selling and buying prices accordingly. This is how a company can continue to see their share price value rise over time.
If this sounds complicated, it’s really not. Sure, the actual math and predictions are complicated. Businesses use professionals with extensive experience in market valuation to help them determine both initial share price at IPO and true value for strategic planning. However, the concept is simple: the longer a company consistently shows improvement in their products and services over time, the more people believe in the company’s continued longevity, and so the more that the company is worth. While other external factors in the market can affect this on a daily basis, the share price over time will generally rise.
It’s a Reciprocal Relationship
So, the share price helps a company determine their intrinsic value. However, companies take multiple other factors into consideration in addition to the share price as they make that determination. They then use this information about their intrinsic value to strategically plan their future. If it plays out as planned, they begin doing even better as a company. This, in turn, increases their share price. Then the process begins anew.
Read More:
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- From Bitcoin to Bullion, the Tangibility of Currency
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Kathryn Vercillo is a professional writer who loves to live a balanced life. She appreciates a good work-life balance. She enjoys balance in her relationships and has worked hard to learn how to balance her finances to allow for a balanced life overall. Although she’s only blonde some of the time, she’s always striving for total balance. She’s excited to share what she’s learned with you and to discover more together along the way.
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