Whats the Difference between intrinsic value and market value of shares?

Although market value and intrinsic value both serve as methods for evaluating a company, the difference between intrinsic and market value lies in their distinct approaches to evaluating a company's worth.

What is Intrinsic Value?

Intrinsic value represents a company's true worth, independent of market influences. It's a key metric in evaluating a company, focusing on both tangible and intangible factors. Analysts use various methods, like discounted cash flow analysis or book value, to estimate it. However, challenges arise due to discrepancies in balance sheet accuracy.

What is Market Value?

The market value of a company reflects its share price, which can be higher or lower than its true worth.It's determined by multiplying the share price by the total outstanding shares. However, this value doesn't always accurately represent the company's worth, as it's influenced by public sentiment and market demand. Estimating market value is further complicated by illiquid assets. High demand can lead to overvaluation, while low demand can result in undervaluation.

Is there a term to describe the difference between market value and intrinsic value of a stock?

To accurately measure this gap, we use the price-to-book ratio, as real numbers often misrepresent it.

 

Price to book ratio = Market Value of the share divided by Intrinsic value of the share

A higher ratio indicates a greater disparity. In an efficient market, this ratio should ideally be 1.

Analysts use this ratio to assess a share's potential, often comparing it with the return on equity (ROE) ratio to evaluate how effectively the company utilizes shareholder funds to generate returns.

Intrinsic value vs market value

Both intrinsic and market value contribute to a company's overall performance and market capitalization. Here's a tabular breakdown highlighting the difference between intrinsic and market value:

 

 

This table illustrates the distinguish between intrinsic value and market value of shares in evaluating a company's performance and market standing.

Intrinsic value vs market value Detail Overview:

• If a stock's intrinsic value exceeds its market value, it's considered "undervalued," making it attractive to value investors.

• Conversely, if a stock's intrinsic value is lower than its market value, it's deemed "overvalued" and less favored by value investors.

 

Market value is influenced by demand and supply, which, in turn, is shaped by public sentiment toward a company. For instance, negative public perception due to unfavorable budget announcements can lead to a temporary decrease in stock prices, despite no immediate impact on a company's earnings or sector profitability. This panic-driven sell-off can result in undervaluation, followed by a corrective upward price movement once calm prevails.

 

On the other hand, positive news, such as a company's new project or potential developments in its operating environment, can trigger rapid stock price appreciation. However, such news may not immediately translate into increased profitability or tangible returns for investors. Consequently, the stock may become overvalued, leaving room for a downward price adjustment in the future.

 

Nutshell

Understanding the difference between intrinsic value and market value of shares is crucial for investors. While intrinsic value represents the true worth of a company, influenced by analysis methods, market value reflects public sentiment and perception of the stock's value. Comprehending both these aspects helps investors make informed decisions and mitigate risks, ensuring optimal return on investment. Therefore, investors should consider both intrinsic and market value when evaluating company shares before making investment decisions.

Frequently Asked Questions

1. What is the difference between intrinsic value and market value of shares?

Intrinsic value represents a company's true worth, while market value reflects its share price influenced by public sentiment.

 

2. How is intrinsic value calculated?

Intrinsic value is calculated through fundamental analysis, considering tangible and intangible factors such as assets, earnings, and growth potential.

 

3. What determines market value?

Market value is determined by multiplying the current share price by the number of outstanding shares, reflecting investor sentiment and market demand.

 

4. How can investors measure the difference between market value and intrinsic value?

Investors use the price-to-book ratio, comparing market value to intrinsic value, with a higher ratio indicating a greater disparity.

 

5. Why is understanding the difference between intrinsic and market value important for investors?

Understanding the distinction helps investors make informed decisions, identifying undervalued or overvalued stocks and mitigating risks for optimal returns on investment.