Question

Market Capitalization

I do understand that market capitalization is defined as the value of the outstanding stock of a company in the market, but when the market of that company goes down, does the value of the company also go down, or are the assets lost?

I am not really understanding how that works. A company does need to have a high market of resources in the business industry, and they need the financial backing in the business world, otherwise, the business will not gain business or respect of other organizations in the same field. There are many different companies within the same field of business, and they all compete against one another, but the market capitalization needs to be there in order for the business to remain competitive

Answer 1

I like the way you have posed a pretty intuitive question.

Lets begin with a simple share value. The value of share can be calculated in a number of ways:

• Free cash flow valuation
• Dividend Valuation
• Income valuation
• Equity or Book value valuation

Now all these methods may yield considerable different valuations. Now when you value a share using income or cash flow approach you are simply adding up all the cash flow income or dividends received in future to the present (discounted value). Therefore when you hear a news that the company has performed well in annual report (EPS is high, cash flows are great etc), it does not happen that the assets of the firm have increased but the investors anticipate greater future earning from per share of the company. Therefore the price increase and market capitalization also increases.  

Now sometimes the company may get a patent. A patent is an asset, and until and unless it is rewarded, the company has no asset (even though it may have spend a lot of assets in R&D). As soon as patent is awarded, the company share prices jump up. This happens for 2 reason: There is an asset value to that patent and the patent may increases future cash flows. Therefore the increase maybe due to an increase in asset or future earnings.