As a investor, before investing in a publicly traded company, you should know when a stock is over or undervalued. To find it out, the first thing you should know is the intrinsic value of a stock and then compare it with the current market price.
In this article, we will be discussing the difference between intrinsic value and current market value of a publicly traded company and how it can help you to take a investment decision.
What is market value?
Market value of a stock is the amount that investors have attached to a company at a particular point of time. In simpler terms, it’s the price you pay now to buy stock of a publicly traded company.
When an investor sell a stock, it means there is another investor who has bought it because to him, the selling price is attractive at that point of time.
In share market, buyers and sellers continuously pushes stock’s market prices up and down. Price of a particular stock settle at a point where the demand equals to the supply of a share. It measures public sentiment about the company’s future based on number of factors. Therefore, current market price of a stock may be significantly higher or lower than the estimated price of a stock.
Market capital of a company is calculated by multiplying a stock’s current market price per share by the number of shares outstanding.
What is intrinsic value?
Intrinsic value is also known as the fundamental price of a share. You have number of ways to calculate it. In general, its the amount calculated based on the money a company is expected to earn over its lifetime. This means, it’s the estimated true value of a company regardless of the present market price of a stock.
Investors including Warren Buffett who invest in stocks based on fundamental analysis are constantly searching for stocks that is trading at or below intrinsic value.
Number of factors including financial statements, management, market analysis and company’s growth projections are considered when setting the estimated true price of the stock. If you are lucky in getting stocks below intrinsic value, then you will have a bit of protection if share price were to fall further, known as margin of safety.
Market price can be significantly higher or lower than the intrinsic value of a stock. If it’s higher than intrinsic value, then the stock is overvalued. The opposite is undervalued, that is when the current stock price is lower than the estimated true value. Investors always look for undervalued companies to invest.
But, it’s not always right to avoid a stock which has lower intrinsic value than the current market price.
You should consider other financial tools of fundamental analysis to have a complete picture of the company before investing.
Financial tools such as Price to Book (P/B) ratio, Price earnings (P/E) ratio and return on equity (ROE) might help you for taking a investment decision.
Please note, it’s difficult to determine market price and intrinsic value of a private company as these company’s shares are not traded on the stock market.
