Price and value are two terms used often in the valuation world.  While we may think they are the same thing, they may really not be.  In a recent webinar by Business Valuation Resources, Dr. Aswath Damodaran, professor at the Stern School of Business at New York University, discussed the differences between price and value. 

He defined value as being based on the fundamentals and objective analysis of cash flows, growth in cash flows and risk in future cash flows.  In the valuation world, the value of a particular asset derived from this type of analysis is referred to as an asset’s intrinsic value.  An asset’s intrinsic value is derived from methods such as a discounted future cash flow analysis and the capitalization of income.  The intrinsic value of an asset may, and most likely will, differ from its current market value.  If a market were truly efficient with perfect competition, the intrinsic value would converge with price.  However, most often that is not the case.  Theoretically, if an asset’s intrinsic value is above its current market value, then there is upside potential in the current price of that asset.  This is known as value investing.    

Alternatively, he defined price as being solely a function of supply and demand.  Obviously, fundamentals and analysis of cash flows play into the equation, but according to Damodaran it is emotions, momentum and irrational behavior that are the driving forces behind the current price of an asset.  Think about product hype and how it can drive up a public company’s stock price.  Or, think about the herd mentality of investors during the dot com bubble.  On the other hand, consider how misinformation can tank a company’s stock.  Other factors such as the overall amount of liquidity in market at a particular point in time and the positions of market makers can influence market prices.  Think about the free flowing mortgage loans and influences of the ratings agencies during the mid-2000s and the resulting irrational increase in the price of real estate. 

If we accept the notion that price and value are two different things, then as valuation analysts in the appraisal business, we must be aware of the differences between the anticipated “value” of an asset and the expected “price” an asset would receive if it were bought or sold.  We must reconcile those differences and be mindful of the forces driving the differences if we are going to arrive at an opinion of value that is both meaningful and useful.