Fair value: what a company is really worth
Price is what the market charges today. Value is what the business is actually worth. Telling them apart is the foundation of investing.
Fair Value
The lesson in plain words
The same lesson as the slides above, written out in full.
1. Fair Value
Welcome. Every investor eventually asks the same question. Is this stock worth what I am paying for it? Fair value is the attempt to answer that. It is an estimate of what a company is genuinely worth, independent of where the market happens to price it today. The distinction between price and value is the foundation of all investing. Price is what the market charges you right now. Value is what the business is actually worth, based on its future cash flows, its assets, and its earning power. One note before we begin. This is financial education only, not financial advice.
- Fair value is an estimate of what a company is genuinely worth, apart from its price.
- Price is what the market charges today; value is what the business is worth.
- Telling the two apart is the foundation of all investing.
A quick note: This is financial education only, not financial advice. Do not buy, sell, or hold anything based on this lesson.
2. Price Is Not Value
The key distinction is this. Price is the number on the screen, and it swings with the market's mood from minute to minute. Value is different. It is what the business is genuinely worth, grounded in its future cash flows, its assets, and its earning power. Price and value are usually related, but they can drift far apart, and stay apart, for long stretches of time. The whole game of investing, at its core, is to buy when the price sits meaningfully below the value, and then to be patient while the gap closes.
- Price is the number on the screen, set by the market's mood minute to minute.
- Value is what the business is worth on its cash flows, assets and earning power.
- Price can wander far above or below value for long stretches.
- Investing is buying when price sits below value, then being patient.
3. Three Ways to Estimate It
So how do you actually estimate value? There is no single correct answer, it is always an estimate, and reasonable people will disagree. But there are three common approaches. The first is discounted cash flow, where you project the company's future free cash flows and discount them back to today's dollars. It is the gold standard in theory, but it leans heavily on your assumptions about growth. The second is relative valuation, comparing the company's multiples, like its P E, against similar companies. If the sector trades at eighteen times and your stock trades at twelve, it might be undervalued, or there might be a reason. And the third is asset based, simply adding up what the company owns and subtracting what it owes. That works best for asset heavy businesses like real estate or banking, and less well for companies whose worth lies in brand or intellectual property.
- There is no single correct fair value; it is always an estimate.
- Discounted cash flow projects future cash and discounts it to today; the theoretical gold standard.
- Relative valuation compares multiples like P/E against similar companies.
- Asset-based adds up what a firm owns and subtracts what it owes; best for asset-heavy businesses.
4. Reading Price Against Value
Finally, how do you read a stock against your estimate of value? If it trades twenty per cent or more below fair value, it is potentially undervalued, and it is worth investigating what the market might be missing. If it sits within about ten per cent of fair value, it is roughly fairly priced, and your returns from there will likely just match the company's underlying growth. And if it trades twenty per cent or more above fair value, the market is pricing in optimistic expectations. That is not automatically a sell, but understand the risk. If those high expectations disappoint, the correction can be sharp and swift.
- Trading 20% or more below fair value: potentially undervalued, worth investigating what the market misses.
- Within 10% of fair value: roughly fairly priced; returns will track the company's growth.
- 20% or more above fair value: the market is pricing in optimistic expectations.
- If those expectations disappoint, the correction can be sharp.
One common way to estimate it is a discounted cash flow: see DCF.
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