If you ask a business appraiser, you will hear: business value is in the eyes of the beholder. In formal jargon, business valuation results depend on the standard of value you use.
One of these standards is known as the intrinsic value. As the name implies, this is the measure of value one figures out by focusing on the fundamental characteristics that create value in a company. Note that this is very different than the fair market value that is often used by business people when comparing a company to other firms.
Intrinsic value is the price of business ownership that is determined by a valuation analyst following an in-depth or fundamental review of the company’s earning power, assets, and other value drivers.
In layman’s terms, the company’s intrinsic value is its true or real value, something that is revealed after careful consideration of all the value creating factors. An analyst setting out to figure out the company’s real worth will study its products, customer base, competitive position, relationships with suppliers, capital resources, management, skilled staff, among others.
When fair market value and intrinsic value converge
What happens if many serious investors do this analysis and arrive at pretty much the same value number? Now the intrinsic value becomes the company’s market value as these leading investors cast their votes by buying or selling company’s stock at a certain price.
Business valuation – foundation of sound investment
Figuring out intrinsic value for any business is no easy task. It is named fundamental analysis for a reason. If you really want to know what a company is worth, you roll up your sleeves and delve into a rigorous study of all the important elements that create or destroy value in the firm. Your investment decision is then guided by your conclusions: is the company’s stock priced higher, lower or in line with your findings?
Weeding out the hype
This lets you weed out market hype and inflated prices and zero in on value priced companies worth your while. The serious investor is rewarded with insight into promising companies before the market sentiment catches up. You get to hit pay dirt before the gold rush sets in.
Note that the legal definition of intrinsic value may differ from the economic concept. When in doubt and facing a legal challenge, check with your attorney on how the case law or local statutes see it.