How to calculate the market value of a company

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There are several ways to calculate the market value of a company. This is of critical importance to an investor, who wants to understand whether it makes sense to buy or sell a firm’s shares.

Valuation of a Company by Stock Price

When the shares of a company are already publicly-held, the easiest way to calculate its market value is to multiply the number of shares outstanding by the current price at which the shares sell on the applicable stock exchange. If the shares only trade over the counter, then the trading volume may be so thin that the trading prices are not realistic.

Valuation of a Company by Sales Multiples

A reasonable alternative is to develop a multiple of the sales for those companies that have reasonable trading volume to their market prices, and apply this multiple to the sales of the business. This latter approach can be subject to some uncertainty, since the more robust comparison entities may justifiably be worth more than the companies for which a valuation is being compiled. If so, it is likely that an excessively high market value will be generated.

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Valuation of a Company by Comps

Another valuation approach is to investigate how much similar companies are selling for as a percentage of their sales, and use the same multiple to develop an estimate for the business. A major flaw in this approach is that the best companies are more likely to be sold first, and so attract the best multiples; companies selling after this first tranche do not perform as well, and so should probably sell at a lower multiple.

Valuation Examples

As an example of the first situation, a business has 1,000,000 common shares outstanding, which trade at $30 on a major national exchange. Its market value is $30,000,000. As an example of the second situation, a company is developing a market value for itself based on a comparison to another business. The other business has a sales to market value ratio of 0.5 to 1. The company being measured has sales of $5,000,000, so its derived market value is $2,500,000. As an example of the third situation, the average selling price as a percentage of reported sales within an industry over the past year has been 50%; a business is currently generating annual sales of $50 million, and so might expect to sell for $25 million.