Intrinsic value is a mathematically derived assessment created by investment analysts to estimate a company’s worth. Market value is the actual price paid for company shares in the marketplace.
If a stock has a significantly lowerintrinsic valuethan its current market price, it looks like a red flag that the stock is overvalued. But that's not necessarily the case.
The disparity between intrinsic value and market price is known in the investment world as theprice-to-book ratio(P/B):
- Price is the current value of the stock as set by the market.
- Book value is the amount a shareholder would be entitled to receive, in theory, if the company was liquidated.
The market price of any stock is almost never the same as its intrinsic value. Generally, when the market value is greater than the intrinsic value, the stock may be described as “overvalued.” That means the market might expect earnings to increase and is assigning a higher value to the company.
When intrinsic value exceeds the market value, the term undervalued may be applied. That means the market doesn't believe in what the company is worth according to its balance sheet for various reasons.
Key Takeaways
- Market value is the current price of a company's stock as it's traded on the Nasdaq or the New York Stock Exchange.
- Intrinsic value is an estimate of a company's worth and can be calculated by taking the sum of all of the company's assets minus its liabilities, or the discounted cash flow established by investment analysts.
- The price-to-book ratio (P/B) is just one factor to look at in deciding whether a stock is overvalued or undervalued.
Market Value
Market value is the price investors can pay for a company’s stock as it trades publicly, and it is determined by supply and demand. The price of a stock reflects the current demand for it. If there is a strong demand from investors for a particular stock, its market price will rise.
Although a stock may appear to be overvalued, at least temporarily, that does not mean that it should not be purchased or at least considered.Over-valuationandunder-valuationare everyday occurrences.
The goal for any investor is to buy low and sell high. If an investor believes that a stock can very likely be sold in the future for a higher price than its current market price, it may well be an excellent investment, regardless of the company's current intrinsic value.
Intrinsic Value
Intrinsic value is similar to book value, but they are two different ways to measure the value of a company. Book value is a company's total assets minus its total liabilities. That seems like a fairly straightforward calculation. A company may own a headquarters building, a theme park, or a casino. It probably has borrowed a certain amount of money.
But what are its patents or its copyrights worth, for example? Or its intangible assets like goodwill or brand recognition? Traders are mindful that book value is not a completely reliable number or, for that matter, a stable one. One hot scandal can destroy a lot of goodwill or brand recognition. The value of a company's physical assets can change with the economy, with consumer tastes, or with time.
Intrinsic value represents a measure of a company’s worth by assessing either its book value or using discounted cash flow analysis, a math formula reflecting analyst estimates of future earnings and which factors in estimates of the discount rate, the short-term interest rate set by the Fed.
Warren Buffett’s mentor, Columbia University Professor Benjamin Graham, wrote about intrinsic value and value investing techniques in his classics on the subject, "Security Analysis," originally published in 1934, and "The Intelligent Investor," originally published in 1949.
Graham’s work remains the go-to reading for those interested in valuation, even as it’s greatly amended or even ignored by modern Wall Street analysts depending on their orientation toward growth or value.
Other metrics for value
It's important to understand that a stock's P/B ratio is just one metric to consider. Analysts commonly examine a company and its stock price from several angles in an effort to get the most accurate assessment of its genuine value. Price-to-earnings, debt-to-equity, and other factors are also in the mix.
A good complementary evaluation measure to a P/B comparison is the return on equity ratio. This is an indication of how efficiently a company is using its shareholders' equity to generate additional profits.
Market Value vs. Intrinsic Value
Market Value
The price investors pay for a company’s stock in the marketplace
Determined by supply and demand. It's the price that buyers are willing to pay and sellers are willing to accept
Reflects investor perceptions about a company's business prospects
Intrinsic Value
A measure of value that considers the future earnings a company is expected to generate for investors
Calculated by using fundamental and technical analyses to gauge a company's financial performance
Discounted cash flow analysis is often used to determine intrinsic value and estimate how a business may perform in the future
Why Intrinsic Value Matters
As a measure of a stock’s worth, intrinsic value provides the investor with the most basic of indicators. Is the market price above or below the intrinsic value? Is the market value of an individual stock above or below that of the stock market as a whole? Is it above or below that of the sector as a whole?
The answers to those questions can help an investor understand whether a certain stock is undervalued or overvalued, and whether that stock is worth purchasing at this time.
Establishing a generally agreed-upon baseline provides a sense of direction for those making investment decisions.
Calculating Market Value vs. Intrinsic Value
The market value of a stock is available online every day during market hours or afterward. It’s printed daily in newspapers as well.
Typically, the last price of the daily session is designated as the closing price, and the listing shows the high and low for the day, the percentage gain or loss, and the 52-week trading range for the security.
Intrinsic value can be calculated using the discounted cash flow model. This centers on using estimates of future cash flows and the present value of future cash flows. The math is more extensive and varies depending on which investment bank analyst's model is being used.
Beyond calculations, the book value of a stock can be found on many different financial websites. This may differ from the valuation opinion of Wall Street investment analysts, who use proprietary techniques to arrive at their own estimates.
Example of Market Value vs. Intrinsic Value
Monster Beverage (MNST) is a Nasdaq-traded stock that closed on March 6, 2024, with a price of $58.42 per share. That’s the market value. The book value is $7.90 per share. The market value is 639% above the intrinsic value—not that astonishing for certain types of growth stocks during a period of bullish excitement about the potential for improved earnings.
The difference in the two measures has to do with investor and analyst enthusiasm about the company. The anticipation of greater profitability in the next few quarters or years brings in Wall Street money managers wishing to outperform.That Monster is a component of the Nasdaq 100 likely attracts interest from investors seeking hot growth names.
McEwen Mining (MUX) is a New York Stock Exchange-traded equity that closed on March 6, 2024, with a price of $7.97. Its book value is $10.16 per share. McEwen thus trades at a 24% discount from its book value, suggesting that investors are not excited about future prospects.
The mining and metals sector has lagged behind the rest of the stock market. Companies involved in this business are avoided or ignored as investors seek greater earnings potential in other areas. Value investors screen closely for stocks like McEwen as longer-term prospects may eventually improve—and the price seems cheap.
Monster is an example of a growth stock—or a stock that is perhaps overvalued. Meanwhile, McEwen might be described as a value stock or even as undervalued, depending on which investing style is being considered.
Should Market Value Equal Intrinsic Value?
There is no reason market value should equal intrinsic value. One of the basic functions of the marketplace is to set value expectations higher or lower depending on the individual equity or sector. Stock prices, or market value, may greatly exceed or fall short of intrinsic value.
What if Intrinsic Value is Greater than Market Price?
Market value may exceed intrinsic value if expectations for increased earnings are the central factor. On the other hand, market value may be less than intrinsic value when most investors have fewer or no expectations for greater profitability.
How Do You Know If a Stock Is Undervalued?
If the intrinsic value is greater than the market value, that's the classic gauge indicating that a stock is undervalued.
The Bottom Line
Market value is the current price of the stock as it's traded in the marketplace. Intrinsic value is often calculated by using discounted cash flow analysis.
When a stock's market value greatly exceeds its intrinsic value, analysts may refer to it as "overvalued." When a stock's market value is less than its intrinsic value, analysts may refer to it as "undervalued."
