Price and value: how a market quote differs from what a business is worth

Separating price from value sits at the base of fundamental analysis, and it is less obvious than it looks.

Price

The result of a transaction between a buyer and a seller. Observable, objective, known to the kopeck — and it asserts nothing about the business.

Value

An estimate of how much money the business will bring its owner in the future, discounted to today. Not observable, dependent on assumptions, and different between any two analysts.

The discount rate

Future money is worth less than money today, and the conversion factor depends on the required return. That in turn depends on the risk-free rate — that is, on the central bank's key rate.

This explains why rising rates lower the valuation of companies whose main profits lie far in the future: The key rate: how a Bank of Russia decision reaches your portfolio.

Multiples as a shortcut

A full calculation requires forecasting cash flows years ahead. Multiples are a fast way to compare companies without building a model: P/E: what it is and why low does not mean cheap and EV/EBITDA: when it is more honest than P/E.

They do not answer "what is it worth"; they answer "more or less expensive than similar ones".

The practical conclusion

The gap between the price and your own estimate of value is what a decision rests on. Having no estimate of your own means the decision is being made on somebody else's.