What Is Value?
Value is the monetary, material, or assessed worth of an asset, good, or service. "Value" is attached to a myriad of concepts including shareholder value, the value of a firm, fair value, and market value. Some of the terms are well-known business jargon, and some are formal terms for accounting and auditing standards of reporting to the Securities and Exchange Commission (SEC).
- Value is the monetary, material, or assessed worth of an asset, good, or service.
- "Value" is attached to a myriad of concepts including shareholder value, the value of a firm, fair value, and market value.
- Comparing the different values and valuations of a company to other companies can help with determining investment opportunities.
Value can mean a quantity or number, but in finance, it's often used to determine the worth of an asset, a company and its financial performance. Investors, stock analysts, and company executives estimate and forecast the value of a company based on numerous financial metrics. Companies can be valued based on how much profit they generate on a per-share basis, meaning the profit divided by how many equity shares are outstanding.
The process of calculating and assigning a value to a company or an asset is a process called valuation. However, the term valuation is also used to assign a fair value for a company's stock price. Equity analysts that work for investment banks often calculate a valuation for a company to determine whether its fairly-valued, undervalued, or overvalued based on the financial performance as it relates to the current stock price.
Comparing the different values and valuations of a company to other companies within the same industry can help with determining investment opportunities. For example, if the value of a firm is estimated at $50 per share, but the stock is trading at $35 per share in the market, an investor might consider buying the stock. On the other hand, if the stock is trading at $85 per share, far above the perceived value, the investor could consider selling or shorting the stock.
Below are some common uses for the term value in finance and in the stock market.
A company's market value represents the value according to market participants in the stock market. For valuing stocks, market value is typically synonymous with the term market capitalization. Market cap is merely the profit or net income of a company divided by the total number of outstanding shares of stock.
Book value is the value of a company according to its financial statements or accounting "books." Book value represents the total amount of money remaining if the company liquidated or sold all of its assets and paid off all of its financial obligations, such as debts or liabilities.
A value stock is a company's stock that trades at a lower price when considering its financial performance and fundamentals, which could include earnings or profit performance, dividends, which are cash payments to shareholders, and revenue generated from sales. Typically, investors searching for well-run companies that trade at a discount are called value investors.
Enterprise value is the total value of a company, which includes a company's cash on its balance sheet, short-term and long-term debt as the market capitalization of the company. The enterprise value of a company shows how well the management team its capital, which is financed by debt and issuing equity shares.
In calculating the valuation of a company and its stock price, investors often analyze financial data, but the interpretation of that data can vary greatly between investors, making valuation analysis both an art and a science.
Other Uses of Value
There are many other uses for the term value that goes beyond the stock market. Real estate and homes have a value associated with them. Within a situation, something or someone could add value or be value-added. Value-added describes the enhancement to a product or service by a company, such as an extra feature or benefit. The goal is to increase the value of the product or service being offered. The term value proposition is used in the corporate world to represent a company's promise to its customers that they'll deliver the product or service as a result of doing business with them.
Net asset value (NAV) represents the net value of a company or investment, which is calculated by subtracting the total amount of assets by the total amount of liabilities. Net asset value is typically used with investment funds containing a basket of securities, such as mutual funds.
Valuation of a Company
The term value can also be applied to the value of a company versus the valuation of a company. Although value and valuation are often used interchangeably, the value of a firm is a number, while valuation is expressed as a multiple to earnings, earnings before interest and taxes (EBIT), or cash flow. Earnings represents the profit or net income generated by a company. Cash flow represents the inflows (credits) or outflows (debits) to the cash position of a company during an accounting period.
Discounted Cash Flows
There are various methods that investors use to value a company, depending on what they believe is more important. Some investors use the cash a company generates by applying discounted cash flow (DCF) analysis. The DCF method attempts to forecast or estimate the future cash flows of a company. If a company can generate cash, they can meet their debt obligations, invest in the company, or pay dividends. In other words, DCF analysis attempts to determine investment's value today, based on projections of the cash generated in the future.
Earnings per Share Valuations
When investors calculate the valuation of a company and its stock price, they're essentially comparing how much earnings is generated as a result of another financial metric within the company. For example, one might want to how much earnings is generated as a result of outstanding shares of stock, which is called earnings per share (EPS). Remember, stock and debt issuance are used by companies to raise funds to invest in the business. Investors want to know how effectively the management team is using those funds to generate earnings.
"What's the valuation of the firm?" is not the same question as "What is the value of the firm?" The market valuation would be a multiple of the current trading price to earnings per share (EPS), such as the stock price to book value per share, or another price multiple. Using price multiples allows for valuation comparisons across peer groups. An investor cannot make sense that the value of firm A is $4 billion, and firm B is $9 billion. To make a more informed investment decision, the investor is better off knowing that the valuation of firm A is 15x EPS, and firm B is 18x EPS.