Reviewed by Khadija Khartit
Both intrinsic value and market value are ways of valuing a company. Both can be used by shareholders, new investors, or government agencies to understand the worth of a business. However, though they are theoretically measuring the same thing, the information they provide can have significant differences.
Market value is simpler to measure but strongly impacted by outside factors such as investor demand. Intrinsic value is harder to calculate but based on the fundamentals of a company, rather than on market sentiment.
Learn how each type of value is calculated and what it can tell you about a business.
Key Takeaways
- Intrinsic value and market value are two distinct ways to value a company.
- Market value is a measure of how much the market values the company, or how much it would cost to buy it.
- Market value is easy to determine for publicly traded companies but can be more complicated for private companies due to what information is available and accessible.
- Intrinsic value is an estimate of the actual value of a company based on its business fundamentals. it is separate from how the market values it.
- Value investors look for companies with higher intrinsic value than market value. They see this as a good investment opportunity.
Intrinsic Value vs. Market Value
Intrinsic value is an estimate of the value of a company based on its expected capacity to produce future free cash flows throughout its life. It is an internal value regardless of what the market sets as a value for it at a specific point in time.
Market value is the current value of a company as reflected by the company’s stock price. Therefore, market value may be significantly higher or lower than the intrinsic value. Market value is also commonly used to refer to the market capitalization of a publicly-traded company and is obtained by multiplying the number of its outstanding shares by the current share price.
Important
Both market value and intrinsic value are easier to calculate for publicly traded companies than for companies that are privately held. This is because financial information, including financial statements and share price, are readily available for public companies but often difficult to find for private ones.
Intrinsic Value
Intrinsic value is a core metric used by value investors to analyze a company. The idea is that it is best to invest in companies that have a higher true value than the one being assigned to it by the market.
Intrinsic value is a type of fundamental analysis. Tangible and intangible factors are considered when setting the value, including:
- Financial statements
- Market analysis
- The company’s business plan
- Tangible assets, such as machinery or property
- Intangible assets, such as goodwill or brand recognition
There is an inherent degree of difficulty in arriving at a company’s intrinsic value. Due to all the possible variables involved, such as the value of the company’s intangible assets, estimates of the genuine value of a company can vary greatly between analysts. Another difficult factor in determining intrinsic value is how to value illiquid assets such as real estate and business lines.
Some analysts utilize discounted cash flow analysis to include future earnings in the calculation, while others look purely at the current liquidation value or book value as shown on the company’s most recent balance sheet. Other difficulties can come from the fact that the balance sheet is an internally produced company document and may not be a completely accurate representation of assets and liabilities.
Market Value
Market value is the company’s value calculated from its current stock price. It rarely reflects the actual current value of a company. Market value is, instead, more a measure of public sentiment about a company.
Market value reflects supply and demand in the investing market, indicating how eager (or not) investors are to participate in the company’s future. This can be impacted by a variety of factors such as:
- Positive or negative press about the company
- Positive or negative press about a competitor
- Public knowledge of the industry
- Opinions of board members, founders, or other public figures
- Global economic or political events
Because market value is strongly impacted by public opinion and external economic conditions, it is more likely to fluctuate than intrinsic value. A company with a high market value but a low intrinsic value is considered overvalued; one with a low market value but a high intrinsic value is considered undervalued.
Using Intrinsic vs. Market Value When Investing
The market value is usually higher than the intrinsic value if there is strong investment demand, leading to possible overvaluation. The opposite is true if there is weak investment demand, which can result in the undervaluation of the company.
For example, imagine a potential investor calculates Company A’s intrinsic value and finds that its shares should be trading at $50 per share. However, due to low demand in the market, they’re currently only trading at $25 per share. Company A’s intrinsic value is higher than its market value, which means the price per share is likely to rise. A value investor would be likely to buy shares of Company A because of the high potential for profit.
On the other hand, if Company B’s intrinsic value shows that its shares should be trading at $25 per share, but they’re currently trading at $50 per share, the company is likely overvalued. This could be due to a number of factors, such as negative press coverage of a competitor or being part of an industry that’s seen as “up and coming” regardless of the fundamentals of the company. A value investor would avoid buying shares of Company B because, if the market value were to move closer in line with the intrinsic value, they would lose money.
What Is a Value Investor?
A value investor is someone who looks for stocks that are trading at a lower price than they should based on a company’s intrinsic value or book value. These stocks are currently undervalued, which means they are likely to increase in price and make a profit for an investor.
Why Are Some Stocks Undervalued or Overvalued?
Stocks can become undervalued or overvalued for a number of reasons. Movements in the market can create herd mentality, when large numbers of people sell as a stock’s price is falling or buy as it is rising. Positive coverage of a company or its founders can cause its stock to rise in value, even if the fundamental value of a the company hasn’t changed. Negative coverage of a competitor or of the company’s overall industry can also cause a change in stock prices regardless of the value of the actual company.
What Is Used to Calculate a Company’s Intrinsic Value?
A company’s intrinsic value is often calculated using discounted cash flow (DCF) analysis. In this type of analysis, the company’s cash flows are estimated based on how the business may perform in the future. Those cash flows are then discounted to today’s value to obtain the company’s intrinsic value.
The Bottom Line
Intrinsic value and market value are both ways of valuing a company. Intrinsic value is a form of fundamental analysis that looks at a company’s underlying financials to determine its value. Market value uses what investors are willing to pay for a company to show its current value on the market.
Market value is easier to calculate, but it is impacted by external factors such as public opinion of the company or industry. Intrinsic value is more difficult to calculate but is a more accurate picture of the company’s worth. Both factors are used by value investors, who look for companies with a high intrinsic value but low market value to find investments that are likely to make a profit.
