There are several accounting terms for determining the value of a company in different ways, such as book value, fair value, and face value. It causes confusion among investors as to when to use which value. Each value indicates something different and cannot be used interchangeably.
This article will help you understand the face value, its meaning, the formula used for calculation, and the myths people have regarding this value. It will also help you understand the importance of face value in the stock market and how to use it in analysis.
What is face value?
Face value, also known as par value or nominal value, is the initial price that a company assigns to a share or security when it is first issued in the stock market. Imagine it as the printed price on a share certificate, though it’s more of an accounting metric now than a tangible item.
Key Features:
- Fixed Value: The value is fixed, unless the business starts a stock split or consolidation.
- Accounting Use: Determines the company’s share capital on the balance sheet.
- Set by Company: Ascertained by the business when shares or bonds are issued.
- Not Equivalent to Market Price: A stock may trade at Rs. 1,500 even though its face value is Rs. 10.
- Basis for Dividend: Rather than market price, dividends are frequently announced as a percentage of face value.
Importance of Face Value in Finance
Let us look at the importance of face value in finance:
1. Assists in Determining Share Capital
The company’s face value is used to compute share capital. Businesses apply the following formula:
Share Capital = Face Value × Number of Shares
This aids in figuring out the authorised, issued, and paid-up capital, all of which are important markers of the equity base of the business.
2. Calculations of Dividends
Better dividends attract more investors. However, people often confuse that its calculation is based on the market value of stock, which is wrong. Typically, dividends are stated as a percentage of face value.
For instance, regardless of the market price, investors will receive Rs. 10 per share if a company declares a 100% dividend on a Rs. 10 face value.
3. Reference Point for Corporate Actions
Face value is especially relevant in corporate actions such as stock splits and bonus issues, while actions like buybacks and rights issues are usually based on market or issue prices. These are important actions that a company takes that can have a huge impact on it. If each shareholder receives one additional share for each share they own in a 1:1 bonus issue on shares with a face value of Rs. 10.
4. Investing in Bonds
The face value of bonds or debentures is the sum that the issuer promises to pay back at maturity. It also determines interest (coupon) payments that the investor will receive.
Myths vs Facts About Face Value
Let us address some common myths regarding face value:
Myth 1: Market price and face value are identical
Factual statement: Investor demand, supply, business performance, and market sentiment all affect the market price. However, face value is a set sum that is decided by the company at the time of issuance.
Example: The stock of a company like Infosys may trade at Rs. 1,500 on the stock exchange, despite having a face value of Rs. 5.
Myth 2: Cheaper Stocks Have Lower Face Values
Factual statement: A stock is not necessarily “cheap” or more accessible just because its face value is lower. The market price, not face value, is what an investor actually pays.
For example, two companies may have face values of Rs. 1 and Rs. 10, respectively. However, the company with a face value of Rs. 1 might trade at Rs. 2,000 per share, while the company with a face value of Rs. 10 might trade at Rs. 100 per share, showing that market price determines “cheapness,” not face value.
Myth 3: The Stock Price Affects Face Value
Factual statement: A stock’s face value doesn’t change over time. It is not affected by the market’s daily price changes. It only changes when specific corporate actions are taken, such as:
Stock splits: Which divide shares into smaller units (e.g., from Rs. 10 to Rs. 2).
Share consolidations: Which combine shares into a larger unit (e.g., from Rs. 2 to Rs. 10).
These actions are strategic and occur infrequently.
Bottomline
The conclusion can be drawn that all accounting terms have different meanings and purposes. Face value is different from the market price of the stock. It forms the basis of the share capital of the company. New investors often get confused and perform the calculation of dividends, etc., with the market price rather than the face value.
It is important to understand the clear difference between these terms by brushing up on basic accounting terminology. This will improve your knowledge and understanding of the stock market.