Price and Value: How a Market Price Differs from Fair Value

Price is what a buyer and a seller agreed on in the last trade. Fair value is somebody's estimate of how much a business can bring its owner over its lifetime. The first is observable and updates continuously throughout the session; the second is not observable at all and exists only as a calculation with a set of assumptions. The gap between them is neither a market error nor an analyst's error: it is the difference between a fact and a judgement. It is under no obligation to close, and certainly not by a date that happens to suit you.

Price is a fact of a trade, not a property of the company

Price has no content of its own. It does not say how much a company is "worth" — it says at what quote opposing orders matched at a particular moment. Look at the card for SBER: it shows the last trade and, next to it, the volume that stood behind it. If the volume is small, the price reflects the opinion of a narrow circle of participants who happened to be in the order book, not the consensus of the owners of the business.

An important consequence follows: price is sensitive to the mechanics of trading. A market order is filled at whatever levels are available and itself moves the last quote; a large seller who has to get out today prints a lower price than the same seller would print without the rush. A market order is a tool for speed, and speed is paid for in price. That is why "the market has repriced the company" often means nothing more than "somebody needed cash".

Fair value is a model, not a measurement

There are several ways to calculate value, and not one of them gives a point — they all give a range.

Discounting future cash flows takes a forecast of revenue, margin and capital expenditure, plus a discount rate. Each of these assumptions is debatable, and the result is extremely sensitive to them: shift the rate a little, and the valuation moves noticeably.

The comparative approach gives up on forecasting and asks how much the market pays for similar businesses. The price-to-earnings ratio for the same stock currently stands at no data, and on its own it proves nothing: it merely converts price into units of earnings so that the stock can be placed next to a comparable peer. A related method is precedent transaction analysis, where the benchmark is the actual prices paid in takeovers: it rests on real money, but deals are rare and often include a control premium that a minority shareholder does not have.

The asset-based approach calculates the value of assets net of debt. For a holding company with diverse lines of business, its natural extension is a sum-of-the-parts valuation, where each segment is valued on its own multiple and the debt held at the centre is then subtracted. The method is useful right up to the moment you start counting one and the same cash flow twice.

Why price and value diverge

The divergence has clear mechanisms, and it is worth telling them apart.

Informational: financial statements come out at discrete intervals, while price lives continuously. Between publications on the reports page, the market trades expectations, not facts.

Structural: for some sellers the decision is dictated by a mandate, not by a valuation. A fund with a cap on its exposure to a single issuer sells regardless of whether the price is high or low.

Emotional: market panic turns an isolated triggering of stop orders into a cascade, and on such days price measures the willingness of participants to sit through a drawdown, not the ability of the business to earn. The mechanics are examined in the glossary entry on panic.

Accounting: the exchange rate changes both the valuation of assets and the tax picture. Currency revaluation can change reported profit without any change in operations, and on the tax side the taxation of currency revaluation comes into play — the base is calculated under the rules of 13%, and it does not always coincide with the economic result.

What to do about the gap

The gap is not a trading signal but a reason to formulate a hypothesis. A useful sequence runs as follows.

Step one: decide what you are buying — a share in a stream of cash flows or a bet on a re-rating. For the stream, look at dividend payments and how sustainable they are; the nearest dates are gathered here —

Step two: write down the assumptions behind your valuation before you learn the price. Otherwise the model will bend itself to fit the quote — this is the most common mistake and the hardest to notice.

Step three: define what has to happen for you to admit you were wrong. If there is no such event, what you have is not a valuation but a conviction.

Step four: check against the events calendar whether your assumptions run into a known date — a rate-setting meeting, a record date, a debt maturity.

When "fair value" does not exist at all

There are assets that have no cash flow and no comparable transactions — for them the whole set of methods is inapplicable, and only a cost-based benchmark remains. This is how valuation works in mining, where the cost side is measured indirectly: the article on hash rate shows why even this figure is a calculation, not an instrument reading. The opposite is worth remembering too: in the OFZ market the divergence between price and value is minimal, because the cash flow is fixed by the terms of the issue and the only argument is over the discount rate.

The short conclusion: price is reported to you, value you calculate yourself. To confuse them is to mistake somebody else's haste for your own valuation. Definitions of the terms encountered in the text are collected in the glossary, and quotes are in the stocks section.