How to Determine a Stock Price: Complete Guide to Market Value

Introduction: The Foundation of Every Stock Market Transaction

When we operate in stock markets, whether in New York, London, or Madrid, we are constantly confronted with a fundamental concept that governs all our investment decisions: the market value of a stock. This represents the consensus between buyers and sellers at any given moment, and understanding it correctly is essential for anyone wishing to participate in organized markets.

What Does Market Value Really Mean?

To understand the origin of market value, it is helpful to go back to more primitive exchange systems. In barter, the value of a good arose inefficiently and variably: a certain amount of grain was worth different amounts of cloth depending on availability and need at the time. This inefficiency led to the creation of monetary systems that allowed for precise equivalences.

The revolutionary aspect of money was that it converted all goods into comparable units under a common measure. A bread producer could receive money and then exchange it for any other item they desired, without depending on someone specifically wanting their bread in exchange for exactly what they needed.

In the context of stock markets, the price of a stock operates under the same principle, but regulated by the Law of Supply and Demand. This law states that the price reflects the equilibrium between:

• What buyers are willing to pay (demand)
• What sellers are willing to accept (offer)

Therefore, the market value of a stock is simply the price resulting from this meeting of buying and selling forces in organized markets.

Can We Set Any Price We Want?

A common question among novice investors is whether they can arbitrarily set the price at which they want to buy or sell a stock. The answer is technically yes, but with a crucial limitation: the existence of a counterparty willing to accept that offer.

Imagine a company called “XYZ” trading at €20 per share. If a seller tries to offer their shares at €50 each, they will probably remain unsold because the market has established that the consensus value is €20. Similarly, if a buyer tries to purchase shares at €8 when the market values them at €20, they will hardly find a seller.

This reference price provided by the market is precisely what allows thousands of transactions to occur in an orderly and efficient manner. Without it, we would revert to the barter era: chaotic and ineffective.

Liquidity: A Critical Factor in Price Formation

A frequently underestimated aspect is the importance of liquidity in determining the market value of a stock. Liquidity refers to how easily we can sell a position and convert it into cash.

Occasionally, we see stocks experiencing exponential increases over short periods. However, examining the trading volume reveals it was minimal, meaning few buyers and sellers participated. In these situations, three scenarios can occur:

1. The trade does not execute because there are no counterparties
2. The seller achieves an abnormally high price
3. The buyer obtains an abnormally low price

The problem is that these extreme movements attract inexperienced investors, convinced they will always find liquidity. It is essential to operate only with assets that have respectable trading volumes, sufficient to ensure our orders are executed quickly and without unpleasant surprises.

Primary Market vs. Secondary Market

To fully understand how a stock’s price is formed, it is necessary to distinguish between two trading spaces:

Primary Market (or Issuance): This is where governments, companies, and organizations issue their securities for the first time. Money flows directly to the issuer, and investors receive the security in exchange. Placements can be (pre-arranged) or (indirect) through financial intermediaries.

Secondary Market: This occurs after issuance. Owners of securities trade the “used” assets among themselves. This is the market where we observe daily prices on screens, and where the true market value of a stock is formed.

The market value we constantly refer to always corresponds to the secondary market, where continuous trading between investors takes place.

Market Capitalization vs. Stock Price

There is a direct relationship between the price of an individual stock and the market capitalization of the entire company. Market capitalization (or stock market value) represents the total value assigned by the market to a company at any given moment.

It is calculated as:

Market Capitalization = Price per Share × Total Shares Outstanding

Conversely, if we know the market capitalization and the number of shares, we can derive the price:

Stock Price = Market Capitalization ÷ Total Shares Outstanding

It is important to note that market capitalization does not necessarily match the company’s book value (assets minus liabilities). A company can have substantial net assets but a much lower market capitalization, or vice versa.

How Is the Market Value of a Stock Calculated in Practice?

Fortunately, the calculation is not a manual task for traders. Trading platforms automatically display the real-time price. However, it is useful to understand what happens behind the scenes:

In markets operating via spread (difference), there is an important distinction:

• Bid (Buy Offer): The price at which we can sell an asset
• Ask (Sell Offer): The price at which we can buy an asset
• Spread: The difference between the two, which constitutes the implicit commission of the intermediary

This difference is especially relevant in less liquid assets, where the spread can be significant.

Do All Assets Have Market Value?

No. The presence of a reference price fundamentally depends on liquidity. An asset requires:

• Participants willing to buy
• Participants willing to sell
• Sufficient volume to allow orderly transactions

Large-cap stocks like BBVA have immediate counterparties. Smaller companies may lack them. If we venture into sophisticated products like private equity or unlisted debt, we will likely find no active secondary market, making it impossible to determine a real market price.

Comparison: Market Value, Nominal Value, and Book Net Value

There are three different ways to value a stock, each with different implications:

Book Net Value: Derived from the company’s accounting books. It is obtained by dividing net assets by the number of shares. “Value investors” seek assets whose market price is below this value, assuming that time will correct the discrepancy.

Nominal Value: The original issuance price of the stock. It serves as an initial reference but quickly loses relevance as the company evolves. It can be confusing for novice investors because it often differs greatly from the market value.

Market Value: As explained, it results from the confluence of buying and selling pressure. Higher demand raises the price; higher supply lowers it. It is the most dynamic and the one we observe on screens.

Questioned Efficiency of Market Value

Although market value is a universal reference, it does not necessarily reflect the “true” value of a company. The market makes systematic errors, often driven by:

• Excessive speculation
• Incomplete information
• Herd behavior

Speculative bubbles demonstrate this inefficiency. Investors buy assets simply because they rise, without understanding exactly why. Spain experienced this clearly with cases like Terra, a stock that jumped from €11.81 to €157.60 in less than a year, driven by media fervor and not by real results. Three years later, it was absorbed and finally disappeared.

Another notable case was Gowex, a company that boasted spectacular business metrics but turned out to be a massive scam. Its CEO deceived employees about viability, and the stock price kept rising, reflecting market ignorance rather than the company’s reality. When external investigators exposed the fraud, the collapse was devastating.

These examples illustrate that, although market value is the best available consensus, it can deviate significantly from economic reality for extended periods.

Conclusions: Navigating Market Value

The market value of a stock represents the current consensus among market participants and is the compass guiding daily trading. However, understanding how it is formed is just the first step.

In the current environment, where interest rates have changed drastically compared to a decade ago, the market has shifted its focus from future growth (“growth”) models to current value (“value”) models. This requires analyzing present cash flows, cost structure, and immediate profitability, not just future potential.

Ultimately, the price of a stock is a continuous conversation between what the market believes today about a company and what facts will confirm tomorrow. Our task as investors is to discern when the market is wrong and be prepared to seize those opportunities.