The concepts behind finance and investing can be very complex to most people. Often, looking at your portfolio can prove challenging to the average investor. The numbers shown can mislead those without the right know-how to read financial statements properly. As a firm with the heart of a teacher, our goal is to help teach those to properly understand what is going on with their finances. This article is intended to help readers understand a key financial concept – market value vs. intrinsic value- which will ultimately provide a better understanding of your financial statements.
What is Intrinsic Value?
Intrinsic value is the real value associated with something. For example, stock ABC could be trading for $50, but that does not mean that is its intrinsic value or actual worth. Intrinsic value considers much more, including future cash flow, financial statements, intangible assets, etc. So, the market value of stock ABC could be $50, but the intrinsic value of that stock could be more or less based upon several factors.
What is Market Value?
Market value is how much something is worth in the market. From our previous example, stock ABC’s market value would be $50 because that is what it is trading for. Market value could almost be seen as the public opinion of a stock.
Real World Scenarios
Market and intrinsic value do not apply only to stocks. Another example of how to understand the difference could be with cars. Say there is a 1966 Mustang for sale, selling for only $1,000 due to many internal issues causing it not to start. The market value of that car is $1,000 since that is what it is currently selling for. However, some could see that the car could be fixed up and turned into a good-looking classic car, which would boost its market value significantly. This would factor into the car’s intrinsic value. Although the car is only selling for $1,000 currently, its intrinsic value is much higher than that since it has the potential to be worth more.
A real-world application of the difference can be seen with what happened to GameStop’s stock (GME). In 2021, investors drove prices to a record high of $347.51 to counteract hedge funds who thought the company was doing poorly and that the price would soon reflect that. The market value at that time would be $347.51 per share, but in reality, the intrinsic value of a share would be much less than that, as the company’s true value was not worth $347.51 per share.
Often, the easiest place to see the difference between market and intrinsic values is fixed income, especially on a cost basis. The cost basis usually reflects the market value of the fixed income. If you were to sell a fixed income before maturity, you would not get back nearly as much as you put in. As you approach maturity, the market value of the fixed income will rise since it will be worth more in the market, but the intrinsic value will remain the same. The intrinsic value of the fixed income would consider the return, the principal, and the time until maturity. Because of this difference between market and intrinsic value, fixed income can often look like it is worth much less than it actually is from a cost-based point of view. However, that is not the case since it is intrinsically worth more than the market value reflects.
Working with an advisor
Understanding investment terms can be difficult and confusing if it isn’t your daily world. Our team of advisors tries to help you feel comfortable with investing and feel informed. If you want to hear more about intrinsic vs market value, one of our advisors would be happy to discuss it with you! Click HERE to schedule a meeting!