Market value added
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. Conversely, when market value is greater than the cost of invested capital, it indicates that company operations are well run.
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
Market value added method can be used only when the stocks of the company are traded in good volume in the stock market. If the stocks are not traded in volume, i.e, in small volume the calculations can be wrong and may not be useful.
It is to be noted that the stock price movements may be because of the investor emotions and confidence in the company and may not be directly related with the management performance.
Example of Market Value Added
As an example, the investor relations officer of ABC 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||4,000,000||4,700,000|
|Common stock price||5.00||5.20|
|Number of preferred shares outstanding||300,000||375,000|
|Preferred share price||10.00||10.30|
|Book value of invested capital||15,000,000||18,625,000|
The market value added for the prior year is calculated as follows:
(4,000,000 Common shares x 5.00 price) + (300,000 Preferred shares x 10.00 price) – 15,000,000 Equity book value
= 8,000,000 Market value added
The market value added for the current year is calculated as follows::
(4,700,000 Common shares x 5.20 price) + (375,000 Preferred shares x 10.30 price) – 18,625,000 Equity book value
= 9,677,500 Market value added
Based on this analysis, the investor relations officer can highlight an increase of 17,677,500 in market value added since the new management team was hired.