Market Value, Intrinsic Value and Investment Value
Equity valuation or the valuation of any asset is an art. Valuation is not a perfect science and there is no single correct answer to what the value of a security ought to be. Valuation is at best, an informed guess or an informed opinion. As such, when analysts use the term value, they might be using it to describe one of the many concepts that can fall under the umbrella term called value. As students, we must therefore be aware of the different types of concepts related to valuation. This article will explain in detail, the three most popular ones:
Market value is the easiest valuation concept to understand. It simply means the value of the company or an asset as denoted by its ongoing market price. As market prices vary wildly, so does the market value of any company or any asset which is listed on it.
Students tend to get confused trying to find out the difference between market valuation and market price. The truth is that there is no difference at all! The fundamental idea is that markets are efficient and at any point of time the prices reflected by the markets are an informed decision made by the market. The market price therefore is the same thing as market valuation and is based on the idea of efficient market hypothesis.
The concept of intrinsic value has been made famous by famous investors from value investing school like Warren Buffet, Benjamin Graham etc. In simple words, intrinsic value is that value which is imbibed in the asset. For instance, a machine may provide certain incremental benefits to its user over and above what manual labor could have. As such the machine provides incremental cash flows to the firm and has some amount of intrinsic value.
The value of a firm is nothing but the sum total of the value that will be provided by its assets over some selected time horizon. As such, just like the intrinsic value of an asset can be estimated, similarly the intrinsic value of an entire firm can also be estimated.
It is important to understand that the intrinsic value can only be accurately understood and calculated by someone who has an in-depth knowledge of the nature of the firm and the industry. Intrinsic value, calculated by analysts who are armchair experts is often way off the mark and grossly miscalculates what the correct value of the firm should be. Hence, while considering intrinsic value, one must compare and contrast the opinions of multiple analysts.
Intrinsic value looks at the value of a firm in isolation. It only considers that value which can be derived from incremental cash flows that will be produced by a firm. However, consider the case of an oligarch who faces only one competitor. This competitor is driving down the prices that the oligarch could otherwise charge from the customers. Hence, in such a case, if the oligarch can buy out the competitor, he will be able to eliminate the competition and become a monopolist. The benefits that will arise obviously cannot be computed using a simple discounted cash flow application. This may not be an ethical scenario. However, business has in the past witnessed these situations and in all likelihood will witness them in the future as well.
The point being made here is that sometimes corporations experience synergy when they combine their business. Hence, some competitors may be able and willing to pay more for an asset or a company if its fits well with their existing business. This valuation is called investment value. The recent acquisition of Whatsapp by Facebook is one such example of the use of investment value in real life scenarios.
It needs to be understood that investment value is subjective for each buyer. The synergies depend upon the current portfolio of assets that are owned by the acquirer and their strategic vision. Hence, Facebook, Yahoo, Google could have all pitched in for the acquisition of Whatsapp. However, the valuation that they arrive upon will depend upon the strategic fit of Whatsapp in their future plans. Since each company will have a different mix of assets and a different vision for the future. Hence, each company will arrive at a different valuation.
Once again, investment value is subjective. It does not depend upon the asset. Rather, it depends upon the buyer.
Hence, when the term value or value creation is used, it is possible that any one of these concepts is being referred to. An analyst or even a student for that matter must have a clear understanding regarding which measure of value is applicable in which context.
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- Equity Valuation: Definition, Importance and Process
- Market Value, Intrinsic Value and Investment Value
- Applications of Equity Valuation
- Assumptions Used In Equity Valuation
- Qualitative Issues While Conducting Equity Valuation
- Intrinsic Value and Mispricing
- Absolute Valuation Models Vs Relative Valuation Models
- Choosing a Valuation Model
- Sum of the Parts Valuation
- Dividend Discount Model: Advantages
- Dividend Discount Model: Disadvantages
- Single Period Dividend Discount Model
- Two Period Dividend Discount Model
- Dividend Discount Generic Model
- Dividend Discount Model: Gordon Growth Rate
- Gordon Growth Model: Pros and Cons
- Valuing Preference Shares Using Dividend Discount Model
- Link between Present Value of Growth Opportunities (PVGO) and Dividend Valuation
- Dividend Discount Valuation: H Model
- Phases of Growth and Valuation Models
- Dividend Discount Model: Share Repurchase Programs
- Implied Dividend Growth Rate
- Sustainable Growth Rate: Concept
- Sustainable Growth Rate and the Du-Pont Analysis (PRAT Model)
- Spreadsheet Modeling: Dividend Discount Model
- Estimating Future Dividends
- Dividend Discount Models: Some Points to Consider
- Introduction: Concept of Free Cash Flow
- Why Is Free Cash Flow Approach Better Than Dividend Discount Models?
- Free Cash Flow to the Firm vs. Free Cash Flow to Equity
- Calculating Free Cash Flow to Firm: Method #1 (Contd): Treatment of Fixed Capital Expenditure
- Calculating Free Cash Flow to the Firm: Method #2: Cash Flow From Operations
- Calculating Free Cash Flow to Firm: Method 3: EBIT
- Calculating Free Cash Flow to Equity
- Calculating Free Cash Flows: The Case of Preferred Shares
- Changes in Financing Policy: Effect on Free Cash Flow
- Single Stage FCFF Model
- Single Stage FCFF Model to Equity Valuation
- Variations in Cash Flow Models
- How to Value Companies like Netflix?
- Debt to Equity Swaps