Difference Between Market Value and Intrinsic Value of Stocks

Understanding market efficiency is crucial for every trader as it impacts the profit window. However, you might have already heard that the stock market is not known for being efficient or fair, as practical factors make it infeasible. Modern theory believes that people are not paying money for the actual amount of an asset but rather for its market value.

But what is the difference between market value and the actual or intrinsic value of an asset? This article helps you understand the difference between market value and intrinsic value.

• Market value and intrinsic value of stocks are two key players determining market efficiency.
• The market value represents the amount at which stocks are being traded in the market. On the other hand, the intrinsic value of stocks helps determine whether stocks are undervalued or overvalued.
• The intrinsic value is crucial for traders and can be calculated by taking the company’s assets minus its liabilities.

The market value of stocks is, basically, the current market price of stocks at which they are traded in the market. It is directly linked to the demand and supply chain. If the demand for certain stocks is higher, their market value is bound to increase and vice versa. However, the market value of stocks is not an actual indicator of their actual value but rather a value that factors like market condition, demand and supply, and geopolitical climate have created. Regardless, stocks are traded at this value.

The intrinsic value of stocks represents the actual value of stocks as opposed to their market value. It is the core metric that technical analysts use to understand the actual value of stocks rather than just putting their money in based on market value. The intrinsic value of stocks is affected by several tangible and intangible factors, such as the company's financial statements, business plans, and market analysis.

Let’s say a company's stock is trading at Rs. 500 (market value). However, after analysing the company's financial health, earnings growth, and future potential, you calculate that the stock is actually worth Rs. 650 (intrinsic value).

If the market value is lower than the intrinsic value (Rs. 500 vs. Rs. 650), the stock might be undervalued, suggesting it could be a good buying opportunity. However, if the market value is higher than the intrinsic value, the stock might be overvalued and could potentially fall in price later.

An easy explanation: Market value is what people are willing to pay, while intrinsic value is what the stock is actually worth based on its fundamentals.

Calculating the intrinsic value of stocks can be a little tricky, given the different formulas used by traders. For instance:

• Traders who believe in relying on future projections to evaluate the cash flow use the formula: Intrinsic value = CF1/(1+r)^1 + CF2/(1+r)^2 + … + CFn/(1+r)^n.
• Another way to calculate intrinsic value is by evaluating the Price-to-book Ratio. This is done by dividing the company’s current stock price per share by its book value per share.

Both formulas are used to determine the company’s actual financial value before investing in their stocks.

Now that you have a fundamental understanding of both terms, you might be wondering which is more important for stock market trading.

The market value and intrinsic value of stocks are equally important for a trader. The former is the amount a trader has to pay to purchase the said stock, and the latter helps in evaluating whether the said amount is justified.

However, understanding the intrinsic value of stocks plays a major role for traders to make an informed choice. Comprehending the actual value of stocks also enables a trader to determine the entry and exit points. Whether it is a short-term or a long-term investment, the actual amount remains the core metric.

Trading in the stock market is primarily about research and using market analysis tools. As a trader, it is not a smart choice to rely simply on the market value of a stock as it often does not do justice to the actual value of stocks. Decoding the intrinsic value of stocks is the only way to navigate through the complexities of the stock market.