Description: This measurement shows the net difference between a company’s market value and the cost of its invested capital. A negative amount indicates that management has done a poor job of creating value with the base of equity available to it, since investors have reduced the company’s value below the amount of equity invested.
Formula: Multiply the number of common shares outstanding by their current market price. Then multiply the number of preferred shares outstanding by their market price, and add the result to the total market value for all common stock; then subtract from it the original amount of invested capital. When deriving this calculation, be sure to use only the number of shares outstanding, exclusive of any treasury stock. The formula is as follows:
(Number of Common Shares Outstanding x Share Price) + (Number of Preferred Shares Outstanding x Share Price) – (Book Value of Invested Capital)
Cautions: This calculation is a difficult one to make if a company’s stock is either not publicly held or thinly traded, since it is difficult to obtain a market value for any outstanding shares. Even if shares are publicly held, it is possible that some classes of stock are so restricted, such as special voting stock amongst a few shareholders, that it is impossible to determine the value of these classes. This problem can be reduced by obtaining an outside valuation from an appraiser, or by consistently using any of a number of valuation techniques, such as the present value of cash flows, a multiple of sales, or the fair market value of net assets.
Also, an increase in market value may be due to a general run-up in the entire stock market, rather than any particular actions by the management team to improve company value; in a strong bull or bear market, this issue can comprise the bulk of any changes in the market value added measure. Also, perceived investor changes on an entire industry (such as changes in the price of jet fuel on the airline industry) can cause investors to drive the stock price of an individual company within that industry up or down, despite its having positioned itself to be immune from the changes that are driving investor behavior.