Today I will provide a brief overview of valuation and why we need to calculate a business's intrinsic value. In later episodes I will delve further into some of the different valuation techniques such as the discounted cash flow model, providing you with more detail on how to value a business. In this episode we will primarily focus on the difference between price and value.
Intrinsic Value is the calculated value of a business based on its fundamentals such as its level of risk. For example, if the business is carrying too much debt or if the industry under which it operates does not have a foreseeable future, this would greatly increase the risk of the business. Another fundamental item is how much cash flow the business is currently producing or can be expected to produce into the future and also is the business expected to grow and by how much.
Intrinsic business value and market price are not always the same. Market price is the quoted stock price you see on exchanges such as the ASX. This difference in price can be due to many reasons, such as; market hype from investors overreacting to news, a difference in valuations and business expectations between investors and also a lack of volume.
