Investment: How to Assess the Value of a Company
The value of a company is usually the first thing investors in Singapore would like to know before buying shares or before embarking in any form of investment venture. So how can you assess the value of a company? Nowadays, people are usually inclined to connect the value of a product or service with its relative price. If the price of the goods in question is elevated, this usually implies that it is important and precious.
This mentality is not applicable when it comes to shares.
Once in a while, you can take notice of certain observations on how a certain company is big and important because it vaunts an elevated share price compared to its competitors.
This is not the case.
The truth is the share price of a given company is not enough to tell you how important, big and valuable the company is. In other words, the share price of a company is not an indication of the size and value of the company.
Of course, we will not provide you with a specific account on how the share price of a company is established (you have to make use of your favourite browser for that!). Nonetheless, we’ll supply you with some elucidations to make things a little bit simpler and comprehensible.
Supposing you are the owner of a debt-free company and it is assessed to be worth S$100 by a group of professionals whose exclusive motivation in life is to estimate the value of companies like the one you have (mind you, this group is real and authentic and they are called stock analysts).
Let’s also suppose that you’re sick and tired of your company and, instead of closing it definitely, you want to give it away to 10 selected investors.
The best way to uphold this decision is to issue 10 shares, which means one share to each investor. Hypothetically, each given share would be worth S$10 – plain and easy Mathematics (S$100 divided by 10).
Clear at this point, right?
Now let’s continue by supposing that, instead of 10 shares, you would like to issue 100 shares. Thus, each investor would get 10 shares, every share worth S$1 – again, plain and easy Math (S$100 divided by 100).
So if you, the owner of the company, issue 1,000 shares, every investor would get 100 shares, and every share would be worth S$ 0.10.
Do you get the whole process?
Have you observed how the price of a share has no connection with the value of the company? Whether it involves S$ 0.10 per share or S$10 per share, the price tells you nothing about the value of the company (in this case, S$100). Thus, to calculate the value of the company, you’ve got to have a notion on the number of shares that has been issued.
So, we’ll move forward with the discussion:
Supposing, again, that this group of 10 investors believes that your company is really worth S$200 instead of the original S$100 (bear in mind that the original company valuation of S$100 was made by stock analysts).
In this particular occasion, shelling-out S$10 per share (supposing you, as the owner, only issued 10 shares) is considered a really good deal. This is so because to the investors, every share should really have a value of S$20.
There can be various motivations why such investors believe your company valuation is more than it should be (maybe they are aware of information concerning your company that stock analysts have failed to perceive like new technological innovations that would make the difference or probably they believe that with a drastic change of management, the company will finally obtain its goals and get to its full potential).
The fact is, S$200 represents the value of your company according to your selected investors. It is simply a valuation that they have established autonomously, according to their best appraisal and judgement. Such evaluation is also an opinion they have of your company. To the investors, buying at S$10 per share is really a great deal, a bargain, but, as far as the group of stock analysts is concerned, S$10 per share is just a reasonable price.
So what are the key notions you’ve learned here?
1) The important aspect you should bear in mind is the share price of a company is not sufficient to tell you about the real value of a company. This is so because a company can simply influence its share price by releasing more or a lesser amount of shares.
2) Your general perception or notion of the company will reveal you whether the share of a company is expensive or cheap. This means that, if you are not a skilled stock or investment analyst or if you are not equipped with any particular information that may help you to assess the value of a given company, it is sensible and wise to assume you don’t know anything.
3) We did not delve on this, but, all the same, to establish the size of a company, the usual praxis is to multiply the number of shares issued by the company with its share price (in the finance sector, this is called market capitalisation or “market cap” of the company).
So as a sum up, the market cap of your company is S$100 (10 shares issued x S$10 per share, or 100 shares issued x S$1 per share, or S$1,000 shares issued x S$ 0.10 per share).
At this point, let me provide you some interesting information:
Question: What is the biggest company in the world nowadays?
Answer: Currently, Apple, with a market capitalisation of US$560 billion.
The following are some of Apple’s leading competitors. Here you can observe how the share price of every company is not connected with the value or its size.
- Apple’s share price = US$603, market cap = US$560 billion
- Google’s share price = US$608, market cap = US$198 billion
- Microsoft’s share price = US$29, market cap = US$243 billion
Here’s another motivating information.
Question: What company has the most elevated share price in the world today?
Answer: Berkshire Hathaway (i.e. Warren Buffett’s baby), at the price of US$124,940 per share, market cap = US$206 billion
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