Equity Market and Importance of Valuation

  • Oct 28, 2019 AEDT
  • Team Kalkine
Equity Market and Importance of Valuation
What is an equity market?

A market that primarily catalyses the process of trading the shares of companies listed on the same. Simply stated, an equity market facilitates the transaction of selling and purchasing of equity shares among the buyers and sellers.

The companies willing to put their shares available for sale list their shares on the equity market or what is otherwise called a stock market. The investors looking to invest in the equity shares of the company buy shares through the equity market where the shares are listed.

There are many buyers and sellers in the equity market. An investor who has bought shares of a company can sell them to some other investor through the equity market. Availability of multiple sellers and buyers at the same makes it easy for both the parties to make the transactions. The ease of availability of shares for the transaction is known as liquidity.

It can also be said that the equity market or the stock market is the platform where the buyers and sellers exchange the shares of a company. Thus, they are known as stock exchanges.

There are many several stock exchanges across the globe. The prominent ones such as New York Stock Exchange (US), London Stock Exchange (England), Shanghai Stock Exchange (China), The Tokyo Stock Exchange (Japan), Australian Securities Exchange (Australia), are some of the major stock exchanges across the globe.

Handy info about ASX

Having talked about an equity market, let’s take a glance at a few things about the Australian Securities Exchange (ASX).

  • ASX is one of the world’s leading financial market exchanges
  • ASX operates at the heart of the globally attractive, deep and liquid Australian financial markets in a world-class regulatory environment
  • As an integrated exchange offering, ASX provides a full suite of services including listings, trading, clearing, settlement, technical and information services, and other post-trade services
  • ASX is a top 10 global securities exchange by value and the largest interest rate derivatives market in Asia
  • As the first major financial market open every day, ASX is a world leader in raising capital, consistently ranking among the top five exchanges globally
  • It operates markets for a wide range of asset classes including equities, fixed income, commodities and energy
  • With a total market capitalisation of around $2 trillion, ASX is home to some of the world’s leading resource, finance and technology companies
  • ASX’s network and data centre are connected to leading financial hubs
  • Speed, reliability, state-of-the-art technology and the diversity of the user community ignite the success of the Sydney-based ASX Australian Liquidity Centre

The buyers and sellers exchange securities through ASX in Australia. But how would a buyer of equities know about the fair price that should be paid for buying specific shares of a certain company or vice versa?

What is valuation?

In general terms, valuation means to determine the fair value of something. From an investor’s point of view, valuation refers to an analytical process of calculating the current or expected value of an organisation’s asset or of the organisation itself.

The valuation of equity can, therefore, be referred to as a process to calculate the fair market value of the equities. An analyst or investor can choose from multiple techniques to carry out equity valuation. Few parameters that an investor/analyst would look up to for further analysis are the information about the company’s board of management, company’s financial position, the capital structure, potential of growth, etc.

Although the objective of equity valuation is to estimate a value for a firm or its securities, however, what lies at the core of any valuation technique are the fundamentals of the firm’s underlying business.

As an informed investor making an investment decision, it is imperative to develop insights about the importance of valuation. Let’s find the answer as to why does valuation carry a considerate amount of weight.

Importance of valuation

Growth measurement

A rigorous and regular valuation process can prove to be a good tool for measuring the growth of the company. Valuation of the equity gives a clear picture to make a comparison of the business with the competitors’ business. Moreover, an investor can make informed decisions to avoid deviations from the core strategy if the valuation is carried out on a regular basis.

Deal setter

From a company’s standpoint, the process of the valuation of their equities empowers the companies with sound business models to ask for a premium from the investors. In an equity market, the perceived market value of shares keeps changing every now and then backed by the information flowing into the market on a real time basis.

As a result, the companies with less strong fundamentals experience a drop in their valuation. Therefore, the investors and the companies’ both are the advantage of a bargain to strike a good deal.

Develop future path

The picture gained through the valuation of the business becomes the baseline for investors to gauge the decisions taken by the company’s management. After identifying the gaps in the key performing areas of the company, the investors are in a better position to evaluate management when they take capital allocation decisions such as whether to go for dividend payments or buy back securities or re-invest in the operations?

Gauge Investor Sentiments

A good valuation framework enables the investors to look through the lens of “Mr Market” and understand the overall investors’ mood. During the times of good growth, it is a known fact that investors tend to focus more on future prospects and throw caution to the winds, pushing the valuation premium higher and lower during bad times.

Bottomline

Valuation is an imperative tool comprising of various analytical techniques for a clearer outlook towards the company and its equities. In equity investment, valuation can enhance decision making and help the investor to make sound decisions while building a portfolio.


Disclaimer

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