What Are the Terminologies Used in Equity Market?

In the domain of investments and asset valuation, various terms like face value, book value, market value, Replacement Value, and Intrinsic Value carry substantial significance. This guide aims to elucidate the meanings and applications of each term, shedding light on their roles in the realm of finance.

What Is Face Value?

Face Value refers to the nominal or par value assigned to a stock at the time of issuance, serving as the original cost of the stock. It remains constant and does not reflect the actual market value of the stock. When a company undergoes a stock split or reverse stock split, the face value may change accordingly, while the market value adjusts accordingly as well.

Calculation of Face Value in equity market involves two key components: Equity share capital and the number of shares outstanding. It is essentially the Equity Share Capital per share, providing a static theoretical value.

The face value plays a crucial role in dividend calculations, as dividends are typically quoted per share or as a percentage of the face value. Investors should focus on the dividend amount rather than the percentage, as it directly correlates with the face value.

Notably, the face value of shares remains unchanged unless the company opts for a split or merger. In such cases, the face value may decrease (split) or increase (merger), impacting the number of shares held by investors and the dividend calculations accordingly.

Example:

Let's consider a hypothetical company, XYZ Ltd, which issues shares with a face value of Rs. 10 each. Initially, the company has an equity share capital of Rs. 10,00,000, and it issues 1,00,000 shares at the face value of Rs. 10 each.

 

Equity Share Capital = Number of shares issued * Face Value

= 1,00,000 shares * Rs. 10

= Rs. 10,00,000

Now, suppose XYZ Ltd decides to declare a dividend of 20% on its shares.

Dividend per share = 20% of Face Value

= 20% of Rs. 10

= Rs. 2

So, for each share held by an investor, the dividend amount will be Rs. 2.

Now, if XYZ Ltd decides to split its shares in the ratio of 1:2:

New Face Value = Rs. 10 / 2

= Rs. 5

After the split, the number of shares held by investors doubles, but the total equity capital remains the same. So, if an investor initially had 100 shares with a face value of Rs. 10 each, after the split, they would hold 200 shares with a face value of Rs. 5 each.

Equity Share Capital remains Rs. 10,00,000, but the number of shares increases to 2,00,000.

 

What Is Book Value?

Book value in equity market refers to the value of a business as recorded in its financial statements or its net worth. It represents the theoretical worth of a company if all its assets were sold and all liabilities were paid off. Essentially, it signifies the firm's equity. The book value typically changes annually based on the company's performance.

Calculating Book Value:

Book Value = Total Assets - (Total Liabilities - Current Liabilities)

Book Value per share = Face Value plus Reserve per share

The second formula establishes a connection between Book Value and Face Value.It's important to deduct any minority interest component from the book value to arrive at the accurate figure.

An Example:

Let's consider Company ABC, which has total assets worth Rs. 50,00,000 and total liabilities of Rs. 20,00,000. Additionally, it has 1,00,000 outstanding shares with a face value of Rs. 10 each.

Using the first formula:

Book Value = Rs. 50,00,000 - (Rs. 20,00,000 - Current Liabilities)

Using the second formula:

Book Value per share = Rs. 10 (Face Value) + (Reserve per share)

This calculation would provide the book value per share, indicating the hypothetical amount each share would receive if the company were to liquidate its assets and settle its liabilities.

However, it's worth noting that book value has limitations. It's reported annually and may not reflect real-time changes in a company's value. Additionally, it may not account for intangible assets, making it less useful for businesses reliant on human capital.

 

What Is Market Value?

Market Value in equity market refers to the current price of a stock as quoted on the exchange, which may or may not accurately reflect the fair value of the stock. It represents the company's overall worth and is subject to constant fluctuations driven by market dynamics. In the short term, market value changes rapidly based on market sentiment, while in the long term, it is influenced by the company's performance. Market value is the price at which stocks are bought or sold, making it a crucial factor in stock trading. It is calculated by multiplying the current stock price by the number of outstanding shares and is also known as Market Capitalization.

 

Market value takes into account both tangible and intangible assets, but its basis is not fixed. Numerous factors such as profitability, performance, liquidity, and external news can impact a company's market value, reflecting its current trend.

What is Replacement Value?

Replacement Value in equity market pertains to the market value of all assets owned by a company at a given moment. It signifies the cost that a new company would incur if it were to establish itself with the same infrastructure and facilities as those possessed by an existing company. In essence, Replacement Value represents the expense associated with replicating the existing firm's assets in the present day.

What Is Intrinsic Value?

The intrinsic value of a share in the stock markets signifies the underlying or true worth of a company's shares, devoid of external market influences. It represents the hypothetical value of a stock if only the company's fundamental aspects were considered.

Also referred to as real value, intrinsic value is often assessed by analyzing factors such as the company's earnings, revenue growth, competitive advantage, management quality, and economic conditions. Comprehending the intrinsic value of a stock empowers investors to assess whether the market price exceeds, falls short of, or accurately reflects the stock's actual value.

 

Calculating the Intrinsic Value of a Stock typically involves employing the discounted cash flow (DCF) model, which utilizes the following steps:

1. Estimating Future Cash Flows: Analysts project a company's future cash flows based on historical data, industry trends, and market conditions, forming the foundation for determining the stock's real value.

2. Determining the Discount Rate: The discount rate factors in the time value of money and the risk associated with the investment. It mirrors the anticipated rate of return that investors seek and is frequently determined by the company's cost of capital or comparable benchmarks.

3. Present Value Calculation: Analysts discount projected cash flows to their present value using the discount rate, thereby arriving at an estimated real value for the stock.

The formula for calculating intrinsic value using the DCF model is as follows:

 

 

where:

CF = cash flows

r = discount rate

n = time period

By incorporating the time value of money, the DCF analysis provides a present value estimate of the stock, representing its real value.

Nutshell

• Face Value: The nominal value of a stock set during its issuance, representing its original cost but not necessarily its current market worth.

• Book Value: The value of a company's assets as recorded in its financial statements, reflecting its net worth and calculated by subtracting liabilities from assets.

• Market Value: The current price of a stock on the market, indicating its worth based on supply and demand dynamics and often fluctuating with market sentiment.

• Replacement Value: The cost a new company would incur to replicate the infrastructure and assets of an existing firm, representing the market value of all assets at a given time.

• Intrinsic Value: The true worth of a company's shares, determined by its fundamental aspects and devoid of external market influences, often calculated using discounted cash flow analysis.

Frequently Asked Questions

1. What is a good example of Intrinsic Value in Equity Market?

An instance of intrinsic value in the equity market is when a stock trades below its calculated intrinsic value. As an illustration, suppose a stock is trading at Rs. 400 in the market, but analysts assess its intrinsic value at Rs. 600 considering factors such as earnings and growth prospects. In such a scenario, investors might perceive the stock as undervalued.

2. Explain an example of replacement value?

Let's take the case of a toy manufacturer who owns a piece of machinery essential for producing specific toys. While the current market value of this machinery stands at Rs. 10,00,000, the company estimates that the replacement cost for a similar new machine, with identical specifications, would be Rs. 12,00,000.

3. What's the significance of Face Value in the Equity Market?

Face Value in the Equity Market denotes the initial value assigned to a company's shares upon issuance, serving as a foundational indicator rather than a reflection of its current market value.

4. How does Book Value impact Equity Market assessment?

Book Value in the Equity Market represents the tangible net worth of a company, offering investors insights into its intrinsic value derived from assets and liabilities, a crucial metric in investment analysis.

5. Why is Market Value pivotal in the Equity Market?

Market Value in the Equity Market mirrors the current perceived worth of a stock, shaped by market sentiment and investor sentiment, influencing trading decisions and portfolio management strategies.