Image editing software company Canva recently added another round of funding that valued the company at $ 40 billion. 40 billion is a lot of dollars, what does that mean exactly? How are companies rated and what does that mean for investors? An everyday investor doesn't need to know all the details of a company valuation to be successful. Still, it makes sense to have a basic understanding of how companies are valued.
What is company valuation?
A company's rating is a measure of how much the entire company was worth. There are many different ways to evaluate a company. This includes historical earnings, future earnings potential or the sum of assets less any liabilities.
In the past, it was common for a company's share price to be a multiple of its annual net income. If General Motors had made $ 3 billion in one year and had 600 million shares, they would have annual earnings per share (EPS) of $ 5.00. Today it is less common for stocks to be valued based only on historical earnings. This is especially true for startups that may not be profitable at all. Instead, they are rated based on their potential for future earnings.
How are public companies rated?
Determining the total value of a publicly traded company is a relatively straightforward calculation and is possible based on publicly available information. To calculate the valuation of a public company, the share price is multiplied by the total number of shares in the company. This is also known as his Market capitalization or market capitalization for short.
Back to our historical (and fictional) example of General Motors from the previous section. In our example, 600 million shares were trading at $ 60 to $ 75. That would give our fictional General Motors company a market cap of $ 36 billion to $ 45 billion.
You may also hear about “large-cap” or “small-cap” stocks. These determinations are based on the total market capitalization of the stock or company. Large-cap stocks are typically those with a market cap of $ 10 billion or more. Small-cap stocks are those with a market capitalization of approximately $ 300 million to $ 2 billion. Mid-cap stocks are companies with an intermediate market capitalization.
How are private companies rated?
There are some similarities with valuing private and public companies. The difference is that privately owned companies don't have to disclose how many shares they own. In fact, private companies don't even have to issue stocks (although most do). In addition, unlike public companies, the shares of private companies are not openly traded so their value is not determined by the market.
Despite this big difference, a private company is usually valued similarly to a public company. They just don't know how many shares a private company has. So if the news reports that Canva raised $ 200 million in new funds at a valuation of $ 40 billion, it could be giving investors 100 million shares at $ 2 per share or received 20 million shares at $ 10 per share, or anywhere in between.
Whatever the price per share these investors paid for their Canva stock, if you multiply that by the total number of shares outstanding by the company, it works out to be $ 40 billion. Since Canva is a private company, we don't know exactly how many stocks there are in total, but it doesn't matter to most people. The average investor can't buy Canva (or any private company) stock, so its share price is what Canva and its investors say.
Conclusion – what does company valuation mean for investors?
You may be wondering what all of this means for me as an occasional investor? The good news is that for most investors, valuing a company isn't something to worry about too much. It's good to know a little about this so that you are familiar with the concept, but there are other concepts that are more important, such as compound interest or Be tied to a budget.
This is especially true if you are a beginner just starting out, you just can invest in index funds as a good start to your investment career. If you're looking to gain more experience and invest in individual stocks, you can use company valuation as a tool to help you decide whether a particular stock is a good investment. Look for companies that you think are rated lower than they should be – these can make good investments.
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Dan Miller (85 posts)
Dan Miller is a freelance writer and founder of PointsWithACrew.com, a website that helps families travel for free / cheaply. His home base is in Cincinnati, but he tries to travel the world as much as possible with his wife and 6 children.