Intrinsic Value vs. Market Value in Stock Trading
Author: James Clark
Before you invest in any company’s stock, learn the difference between its intrinsic value and market value to help you make a better decision.
Thanks to the emergence and advancement of behavioral finance, stock traders are more careful when evaluating their investments according to economic reality. However, new or inexperienced investors are too eager to pounce on stocks as soon as their prices begin to fall, thinking they’re getting a bargain. Similarly, those holding on to those stocks freak out when they fall. They don’t understand that every financial asset has an intrinsic and market value.
In this post, we aim to help investors understand the difference between intrinsic value and market value in stock trading to make better decisions during trading sessions.
What is the Intrinsic Value of a Stock?
In a nutshell, the intrinsic value of a stock is its approximate net present value after taxes, inflation, losses, and discount between the present and the end of time. While this seems like a straightforward calculation, traders must understand that this is not a 100% accurate or stable one. At any given time, there are events and activities within a company that can alter its reputation positively or negatively. For instance, a scandal, leadership changes, or new product launch, etc.
What is the Market Value of a Stock?
In contrast, the market value of a stock is the amount investors are willing to pay at any given moment. In economic terms, a stock’s market price reflects its current supply and demand. Stock traders should understand that overvaluation and undervaluation are quite common, especially among stocks belonging to highly reputable and popular companies. For instance, just because a certain stock is undervalued temporarily, it doesn’t guarantee profitable returns in the long run. Similarly, overvalued stocks are sometimes worth considering as demand for a certain product or service can remain consistently high for years.
The importance of Understanding the Difference Between Intrinsic vs. Market Value in Stock Trading
In many cases, intrinsic and market values of a stock line up to confuse inexperienced traders. Let’s consider an example to explain its importance. Imagine you run a seasonal gelato shop in a popular location that easily brings in $40,000 a year in after-tax income, which is a 100% return. Every summer, you hire a small team to help you run it and maintain high sales. However, even though it’s a lucrative operation, you can’t expect it to grow beyond inflation. Now, imagine an investor offering you $10,000 to buy it, which is nowhere near the market or intrinsic value. You would tell them no without even giving it a thought. But what if another investor offers you $2 million for the gelato shop? You’d jump right in knowing that you can never make the same amount of money with this business as it exceeds its intrinsic value.
Every stock trader aims to buy low and sell high. However, many stocks that appear undervalued are worth the consideration and vice versa. It’s all falls to your evaluation and anticipation of a stock’s future performance, which is what stock trading is essentially about. Learning the difference between intrinsic value and market value can simplify the decision-making process.
1. Avis Budget Group, Inc (CAR)
2. United Rentals, Inc (URI)
3. Controladora Vuela Compania De Aviacion, S.A.B de C.V (VLRS)
Find the top stock picks with guidance on when to sell, buy and further information by subscribing to the PT Premium Service in the Proficient Trader App