The market value added concept derives the difference between the market value of a business and the cost of the capital invested in it. When market value is less than the cost of invested capital, this implies that management has not done a good job of creating value with the equity made available to it by investors.
To derive market value added, follow these steps:
- Multiply the total of all common shares outstanding by their market price
- Multiply the total of all preferred shares outstanding by their market price
- Combine these totals
- Subtract the amount of capital invested in the business
The formula is:
(Number of common shares outstanding x share price) + (Number of preferred shares outstanding x share price)
- Book value of invested capital
As an example, the investor relations officer of Cud Farms is preparing a press release that reveals the increase in market value added since the new management team was hired. The analysis is based on the following information:
|Prior Year||Current Year|
|Number of common shares outstanding||5,000,000||5,700,000|
|Common stock price||$4.00||$4.20|
|Number of preferred shares outstanding||400,000||375,000|
|Preferred share price||$11.00||$11.30|
|Book value of invested capital||$18,000,000||$20,625,000|
The market value added for the prior year is calculated as follows:
(5,000,000 Common shares x $4.00 price) + (400,000 Preferred shares x $11.00 price) - $18,000,000 Equity book value
= $6,400,000 Market value added
The market value added for the current year is calculated as follows::
(5,700,000 Common shares x $4.20 price) + (375,000 Preferred shares x $11.30 price) - $20,625,000 Equity book value
= $7,552,500 Market value added
Based on this analysis, the investor relations officer can highlight an increase of $1,152,500 in market value added since the new management team was hired.
This measurement should only be used if a company's stock is robustly traded on an established stock exchange. Otherwise, a few occasional trades in the over-the-counter market could trigger substantial changes in the market price of the stock, which massively alters the outcome of the calculation. It may be possible to derive the market value of shares by engaging an appraiser to provide an estimate, especially if a company is privately-held.
Also, be aware that the current stock price may be based on changes in investor confidence in the market or industry as a whole, and do not relate to the performance (or lack thereof) of management in running a business.