MARKET VALUE



Market value is the concept of how much something—a business, a piece of property, or anything of value—is presently worth under relatively free conditions of exchange. For tax and legal purposes, the standard definition of market value, or so-called fair market value (FMV), was articulated in the IRS Revenue Ruling 59-60, where it is equated with the price paid for a given property under the construct of a willing buyer and willing seller, both with full knowledge of pertinent facts, and neither being under a compulsion to act. Put simply, market value is the price at which goods trade in an open and competitive market.

For many types of property, the market value is an easily observed quantum. It can be examined by reference to comparable assets that have sold under similar circumstances, such as time, location, condition, terms, and the nature of buyer and seller. In the case of commodities, one need only look at the Chicago Board of Trade figures to determine at what price crude oil, cotton, pork bellies, etc. are trading on a given day. Similarly, for financial assets, such as shares in publicly traded companies, the New York Stock Exchange, Nasdaq Stock Market, or American Stock Exchange stock quote listings can be consulted. The same is true for many debt securities, including corporate, municipal, state, and government bonds.

A loaf of bread, a pair of socks, and various consumer products have observable market prices which can be easily determined by sampling prices charged at various retail stores. The same is true, to a lesser extent, about goods sold in other venues. Because the information about competitive products and competitive dealers is often less than perfect, different buyers may pay different amounts for the same or similar things. The precision with which market value is defined diminishes as the property becomes more unique and when the relevant information is limited.

Real estate is an example of how apparently similar properties can fetch dramatically different prices. Each parcel of real estate is in some way unique from all others, and the circumstances under which a given buyer approaches the negotiation may be quite varied. Some potential buyers may have a desperate need to buy soon or an emotional attachment to the neighborhood that may encourage them to pay more than could be obtained from another buyer. Thus, a seller may list the property at an unrealistically high price and get "lucky" with a particular buyer at the right time and place. Technically, the high trading price establishes a "market value." If the buyer needed to sell shortly thereafter, however, he might find that the property can only be sold for somewhat lower than he recently paid. This price disparity has sparked a philosophical argument over which is the true market value.

The above discussion highlights this fact about determining market value: it is easier to quantify and support a market valuation for generic, non-unique property than for unique property. An easily understood example is the case of a new car versus the same model several years later. At the time of a new car sale, identical cars can be found (or ordered) and picked up by buyers with zero miles, no dents or dings and a full manufacturer's warranty. Here the variance of actual transactions should be low; that is, the market values should be within a tight tolerance of some mean price. Four years later, a subset of the same group of cars may be for sale in the used car market. With used cars, many variables can affect value. The cars' condition and mileage can vary. Availability is more spotty. Therefore, uniqueness is higher, knowledge is less perfect, and comparing competitive options is not as readily done. As a result, the variance of prices paid for the same model used car, at the same point in time, will be much wider about the mean.

For publicly traded companies, one form of market value (more accurately termed market capitalization) is the total value of all outstanding shares of common stock at the current share price. This is often different from how the same business would be valued if it were actually being acquired by another company, when frequently shareholders of the acquired company are given by the acquirer some form of premium over the current trading price of their shares. Alternatively, if the shares being valued are in a privately held company, the stock market price (of a comparable company) may need to be discounted to reflect the lack of marketability, sometimes known as illiquidity.

SEE ALSO : Valuation

[ Christopher C. Barry ]

FURTHER READING:

Jones, Gary E., and Dirk Van Dyke. The Business of Business Valuation. New York: McGraw-Hill, 1998.

Yegge, Wilbur M. A Basic Guide for Valuing a Company. New York: John Wiley & Sons, 1996.



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