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How much are shares really worth?
The price you pay on a stock exchange is, by definition, the going rate.
This market price, in turn, tells you what the entire company is worth. If you multiply the share price by the total number of shares issued by a company, you get the value of the company. This is the company’s market capitalisation (or market cap for short).
Just because the share price of one company is higher than another doesn’t mean the company is worth more though. This is because companies don’t all have the same number of shares. You could have a company with a million shares valued at £1 and another with ten shares worth £100,000. Both companies are worth £1m.
The share price on any given day represents the collective wisdom of what all the buyers and sellers think a share is worth at that point in time. The Efficient Market Hypothesis claims this market price is an accurate indication of value. But is this really the case? The point is hotly debated.
Does the market get it wrong?
The market may not always be entirely rational. It can be prone to bouts of “irrational exuberance” or fits of fear. These may cause a share to move away from its ‘true’ value.
In practice, professional investors use a host of measures to analyse companies in their attempt to work out what they might really be worth. These include studying the company’s assets, management, profit margins, earnings, growth rate and more. The problem is that all of those measures relate to either the past or the present. None of them will tell you exactly what will happen in future. If they did, there would be no need for discussion over what the ‘right’ share price should be.
A few investors have made fortunes working out which companies were over-valued or under-valued cashing in when the reasons for the price distortion disappear. Of course, even if the assessment is correct, there’s no guarantee that the ‘true’ value will ever return and there is no way of knowing how long the market will remain ‘wrong’.
So, there’s uncertainty and there’s irrationality and the result can be dizzying lurches in stockmarkets.
In this video a company chairwoman discusses some ways companies can be valued.
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In financial markets, stock valuation is the method of calculating theoretical values of companies and their stocks.