Two different numbers, not one
The price on screen comes from a buyer and a seller agreeing at a given moment. It can move on news, on someone needing cash, or on the mood of the whole market. Fair value tries to answer a different question: what is this company worth, judging by its profits, its cash and its assets?
Fair value rests on assumptions
No valuation runs without assumptions: how fast will profits grow, how risky is the business, how many times its profit will the market pay? Change one assumption and the answer changes. That is why two people valuing the same company can reach two different numbers, each reaching a result consistent with their own assumptions.
The more honest picture is that fair value is a range, here 18 to 24. The price can stay inside or outside that range for a long time, because nothing forces it towards the estimate.
So what is it good for?
Fair value makes you ask one important question before any decision: what is this price assuming about the company's future? A price that is very high relative to profits may reflect a market expecting strong growth. A low one may reflect a market that sees risk or is pessimistic. The next lessons in this path cover the calculation methods one at a time.
Look at a real company's figures
Open any stock page and set its price against its basic figures, such as earnings per share and the P/E ratio. Ask yourself: what does this price assume?
Check yourself
1. EPS is EGP 3 and you assume the market pays 8 times earnings. What is the estimate?
2. Your estimate is above the market price. What does that mean?
Summary
- The price is the last trade; fair value is an estimate built on a calculation and assumptions.
- Change one assumption and the estimate changes, so treat it as a range.
- Fair value is not a price target and does not say where the stock is heading.