Question

What is a firm’s intrinsic value? Its current stock price? Is the stock’s “true” long-run value more closely related to its intrinsic value or to its current price?

Intrinsic Value

Definition of Intrinsic value

A firm’s intrinsic value is an estimate of its “true” value. It’s based on the company’s expected future cash flows and the risk associated with those cash flows.
This value is what a knowledgeable analyst would calculate, using the best available data about the company’s prospects and an understanding of its risk.
Intrinsic value is an estimate and cannot be measured precisely. Different analysts might come up with different estimates of a stock’s intrinsic value.
A company’s managers usually have the best information about its future prospects, so their estimate of the intrinsic value is often better than an outside investor’s.
Intrinsic value is a long-run concept, and management should take actions to maximize it.

Current Stock Price

Defiition of Current Stock Price

A firm’s current stock price is the actual market price at which the stock is trading. This price is easily found on the internet or in newspapers.
The market price is based on what investors perceive the company’s value to be, given the limited information they have. This means that it might not reflect the company’s true value because investors may not have all the information or might misinterpret it.
The marginal investor, whose views determine the stock’s price, sets the actual market price.
Market prices can differ from intrinsic values, but they tend to converge as time passes.

Relationship to Long-Run Value

The stock’s “true” long-run value is more closely related to its intrinsic value than to its current market price. This is because the intrinsic value is based on a more complete picture of the company’s future potential and risk.
While the stock price is important, it can be influenced by short-term factors like investor sentiment, which may not be aligned with the company’s true long-term value.
Management should aim to maximize intrinsic value because, over time, this will also maximize the average stock price.

Conclusion

Intrinsic value is an estimate of what a company is really worth, based on its long-term cash flow potential, whereas current stock price is based on investor perceptions and market forces that can fluctuate in the short term. The intrinsic value is a more reliable measure of the stock’s “true” long-run value.
Managers should focus on actions that maximize intrinsic value, which will help ensure that the stock price also reflects the company’s true long-term worth

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