Building a robust business valuation requires determination, commitment and a high level of customer service. There are several ways of financial valuation of a business. The two we will discuss here are market value and intrinsic value.
As we learn financial analysis, we will always find fans of either of the two concepts with their logic. However, it is critical to understand the totality of concepts to judge each financial valuation concept's importance and suitability in applicable cases.
These concepts are usually used to value a company and its stock price. Here is all you need to know about the market price and intrinsic value:
What is the market price?
As the name suggests, the market price is the price of the stock in the market. The process of demand and supply determines this price. If the company shares receive strong demand from the public, its market price will go beyond its book value. It is because there are people in the market looking to buy stock in demand.
With the ever-changing demand and supply equation, overvaluation and undervaluation are normal occurrences in the market. It doesn't mean that a stock should be bought, sold or considered for either of the two in case it is overvalued or undervalued.
The market price of a stock is an indicator of the market's current behaviour toward the stock. If the price increases, there is more demand for the stock compared to supply and vice versa.
What is Intrinsic Value?
Intrinsic value is also known as book value. Intrinsic value is the total value of an organisation's assets after deducting the total liabilities. It may seem like a simple calculation in theory, but a business may own tangible and intangible assets with an ever-changing valuation in the real world.
For instance, a business may own office buildings, machinery, factories etc. At the same time, patents, copyrights, and goodwill are the intangible assets of an organisation. Tangible assets depreciate consistently and can change in value with the economy and consumer tastes. Intangible assets like the value of goodwill can change with one crisis for the business.
Similarly, the value of patents and copyrights can change with the value they bring to the table.
Intrinsic value is a type of fundamental financial analysis of a company. There are various models like discounted cash flow and current liquidation value to arrive at the intrinsic value of an organisation.
Difference between Intrinsic Value and Market Price
Both concepts – Intrinsic Value and Market Price – are two different models of financial accounting and valuation that are used in specific cases. It is important to have clarity on both to have a clear picture of operations. Here are the key differences between intrinsic value and market price:
For an investor
From an investor’s perspective, it is better to have a strong intrinsic value than a market price. If the intrinsic value of a business is high, investors view it as a good investment opportunity.
For a company
It is easier to find a publicly listed company's market value than a private company. For an organisation, both these are different ways to value the business. Intrinsic value is the estimate of the actual value of the organisation that is separate from how the market values it.
The basic application of concepts can be applied to the buying and selling of assets. For instance, when the intrinsic value of an asset is high compared to its market price, the asset should be bought. Similarly, when the intrinsic value of an asset is low and the market value is high, the asset should be sold.
What is the price-to-book ratio?
There is hardly a scenario where the intrinsic value will be equal to the market price for a long time. As these concepts are valid and can operate independently, both these values will likely differ.
The difference between intrinsic value and market price is known as the price-to-book ratio. In the price-to-book ratio, the price is the current value of the stock in the market and book value is the price that an investor would receive if the company is liquidated.
Concepts like this and many others have been explained in-depth in the Financial Analysis Prodegree Course from Imarticus Learning. The course has been launched in collaboration with KPMG in India and offers to teach job-relevant skills in financial analysis and valuation. Covering concepts like accounting and financial modelling, valuation and corporate strategy, equity research, M&A, and Job readiness, the financial analysis and valuation course helps you excel in your career with practical teaching and active participation.