The term value refers both to a concept and to a quantity. The concept of value is an economic concept, and it can be progressively refined as follows until reaching a sufficiently unambiguous meaning:

• value
• value, economic
• value, economic, intrinsic
• value, economic, intrinsic, true
• value, economic, intrinsic, true, pure

The term investment value refers to the concept of pure, true, intrinsic, economic value. The phrase expected investment value refers to investment value adjusted for risk and uncertainty . Economic valuation is the estimation of economic value.

Even with all these qualifying adjectives to clarify the meaning, the phrase is awkward and remains ambiguous. A less ambiguous distinction is between deep value and surface value. Deep value is investment value based primarily on intrinsic economic value estimated from expected future discounted cash flows and buttressed by accounting book value, quality and other aspects of value independent of market price. Deep intrinsic value can include qualitative factors such as brand recognition, franchise, corporate governance, labor relations, government contracts and assets that are not usually marked to market. A corporate governance score such as Standard & Poor’s CGS [PDF or HTML ] use criteria that may be indicators of long-term value creation, including both a Corporate Governance Score for a company and a separate Country Governance Classification for its country of origin. The criteria are fairness, transparency, accountability and responsibility, as elaborated in Standard & Poor’s Corporate Governance Scores: Criteria, Methodology and Definitions. July, 2002. Surface value is a misnomer — it is not really value but rather market price, usually expressed as a ratio either with accounting items such as earnings, dividends, net worth, and sales, or with growth rate. Surface value is analogous to unit pricing of fungible commodities by number, by volume, and by weight, for comparison shopping without regard to quality.

The quantity of value is an estimate or approximation. The estimated quantity of value is based on an appraisal or a valuation. It can be expressed either as an interval estimate or a range of quantitative values, or as a single-point estimate or a single quantity of varying precision. Either way, intrinsic value can be quantified as Net Present Value (NPV) based on Discounted Cash Flow (DCF) analysis.

Price is not value, neither in concept nor in quantity. Price is a market-generated quantity. The confusing term market value is really market price. The confusing term fair market value is really fair market price. The fair market price is the price that equals the single quantity that best approximates investment value. The best point estimate of investment value is the mean of the distribution of values rather than the median of the distribution of values or the midpoint of the range of values.

The distinction between human values and economic value is discussed in Investing with Your Values: Making Money and Making a Difference by Hal Brill, Jack Brill, and Cliff Feigenbaum (see citation in General Books). Whereas, the market is an effective mechanism for translating human values into the common metric of price. a valuation model is an effective method for estimating economic value .

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Another term that is used to refer to economic value is fundamental value, which derives the quantity of value from so-called fundamental economic metrics generated by a firm at the firm-level, in contrast to pricing metrics generated by a securities market at the security-level.

Markets often fail due to externalities. An externality is either a cost (negative externality) or a benefit (positive externality) that is not explicitly included in a price. In product markets, there are both production externalities and consumption externalities. An example of a positive production externality is company basic research that leads to discoveries with spillover effects beyond its commercial interests and beyond all commercial interests. An example of a negative consumption externality is the non-recycled waste of a non-renewable natural resource. Remedies for these product market imperfections or flaws are presented in The Ecology of Commerce by Paul Hawken (see citation in General Books). The reason why Earth is facing a man-made ecological crisis is presented in Ishmael by Daniel Quinn, and the complementary reason how we got to this crisis is explained in Guns, Germs, and Steel. The Fates of Human Societies by Jared Diamond (see citations in General Books). Market externalities often are a result of open-access systems known as commons that are discussed in Managing the Commons edited by Garrett Hardin and John Baden (see citation in General Books). Some companies and industries face a larger potential adjustment between their product prices and full product costs. Pricing externalities in product markets have a direct but uncertain impact on company valuations and an indirect impact on prices in capital markets.

Price is not value, pricing is not valuation, and pricing models are not valuation models. The conventional academic capital asset pricing model has one factor, the beta coefficient. Models that include beta are pricing models, not valuation models. This is not merely a matter of semantics. The difference between price and value, referred to as the margin of safety, is the raison d’etre of investment valuation independent of market pricing.

Economic value can refer to either value in use or value in exchange as understood by David Ricardo. For example, water has high value in use but due to an excess supply may have a low price or be free for the taking. Diamonds, in contrast, have high value in exchange due to their real or artificially-managed low supply relative to demand. Michel Foucault in The Order of Things. An Archaeology of the Human Sciences. page 167, writes: A beginning is thought to have been made, too — in the work of Cantillon — on the task of disentangling the theory of intrinsic value from from that of market value; and the great ‘paradox of value’ was dealt with, by opposing the useless dearness of the diamond to the cheapness of the water without which we cannot live (it is possible, in fact, to find this problem rigorously formulated in Galiani); a start is supposed to have been made, thus prefiguring the work of Jevons and Menger, at connecting value to a general theory of utility. The apparent paradox between the value of water and diamonds is resolved by the difference between total utility and marginal utility.

Value in exchange for common stocks may be expressed in either absolute terms or relative to other stocks. Absolute value determined independent of market prices is sometimes called intrinsic value and is what the company would be worth to private owners. Intrinsic economic value is the ultimate, long-term value of an investment; i.e. the present value of the expected dividends and future selling price; i.e. what you can expect to get out of the investment.

The term value can refer to either accounting value, market value, or economic value. Measures of accounting value include book value per share, net worth per share, net asset value per share, and net tangible asset value per share. Market value refers to common stock equity capitalization or financial size, and is equal to the share price times the number of shares outstanding. Publicly-traded market value includes only those shares that are not held in private accounts. Measures of accounting value and market value can be used for quick mechanical screening criteria for filtering out common stocks for further investigation. In contrast, economic value refers to intrinsic, long-term, ultimate value of an operating enterprise as determined by net cash flow analysis using spreadsheets and formulas. Intrinsic value is independent of quoted market prices. Accounting value is commonly confused with economic value. For elaboration on the crucial distinction between accounting and economic value, see the philosophy, styles and screening discussion. Also see the comparison between 1st & 4th editions of Graham & Dodd’s Security Analysis for explanation of intrinsic value concept and its shifting emphasis on growth.

There is no intrinsic value of gold or other commodities. They are inert, non-earning assets. As an investment, gold is a pure speculation because there is no internal creation of value. Industrial metals, such as copper, are less speculative than precious metals because their prices more generally reflect demand and supply. Nevertheless, extrinsic factors operating through buyers and sellers determine the price of every commodity. In contrast, for equities and other claims on assets, their value is intrinsic because it is generated by the underlying operating enterprise in the form of earnings, dividends, and cash flows. There are no intrinsic prices, only intrinsic values.

The method of valuation contrasts with both the method of forecasting growth for the sake of growth and the method of technical analysis. The valuation method considers no daily quotes, no charts, no breaking headlines, and no hot tips. Also, it does not take at face value any broker opinions or brokerage house research: neither fresh, bullish-sales biased, investment-banking compromised, buy/sell/hold recommendations with occasional self-contradictions and internal inconsistency for presentation to the larger institutional customers, nor stale versions of these same recommendations repackaged for smaller individual customers. Most importantly, no forecasts: neither those for official public consumption, nor the private whispered versions shared among colleagues (The Wall Street Journal, 16 January 1997, C1, C20). See citation in General Books. In short, no distractions, just the relevant facts. This, of course, does not greatly increase the demand for such information services.

There are three main types of estimates of the future. In order of increasing sophistication, they can be referred to as the naive, the gullible, and the expert. The naive forecast is based on linear trend extrapolations. The gullible forecast is based on analysts’ estimates, such as provided by S&P Compustat’s Analysts’ Consensus Estimates, ACE, or by Institutional Brokers Estimate System, I/B/E/S. The expert prediction is based on rigorous systematic study of a company, its industry, and the economy.

Forecasts, predictions, prophesies, expectations, and anticipations concern the future. Man has always had an inordinate desire to know the future, and this is exploited just as fully as any other human passion. Aristotle in his Rhetoric (1358 b 1-1359 a 26, pages 32-34) made a distinction between hortatory statements about the future and expository statements about the present time. See the citation in General Books.

Following this lead, John Neville Keynes in his Scope and Method originated the use of the term positive to refer to what is and the term normative to refer to what should be. See the citation in General Books. These terms make the distinction between facts about the present, on one hand, and opinions about either the speculative future or an ideal state on the other hand, respectively. In philosophy, Hume’s law is the insistence that the naturalistic fallacy is indeed a fallacy, and therefore conclusions about what ought to be cannot be deduced from premises stating only what is, and vice versa.

The important point here is that statements about future earnings growth rates are normative, not positive. They are opinions, not facts. No one’s crystal ball is any more reliable than any one else’s. Therefore, if not self-reliant, then one must rely on the expert opinion of others who have different agendas and conflicting interests. Similarly, statements about efficient and rational markets where all prices instantly converge to intrinsic value are normative, not positive. They are not reality, but rather utopian ideals approached by stock markets as complex aggregates but not by individual stocks. Perfectly efficient markets are necessary as a fixed standard for comparison, and thus serve a useful methodological function.

Reliance on the earnings estimates of experts can range from blind faith at one end of the spectrum to reasoned faith at the other end. Even if an investor knows the difference between either cash flow or free cash flow, however defined, and true long-term economic earnings, and even if an investor accepts the operating definition of earnings used by experts, the acceptance of their estimates of earnings and growth in earnings constitutes an act of faith. Ambrose Bierce had some insightful comments about faith, hope, and charity (love) and about education. See the citation in General Books. Is faith in speculation about future earnings more, or less, reasonable than faith in appraisal of today’s value?

Not without reason does the U.S. Securities and Exchange Commission (SEC) censor forward-looking statements about a company’s future prospects by following the Financial Accounting Standards Board (FASB) in their prohibition of making statements about future earnings in the documents filed with the SEC. Forward-looking statements about capital spending plans, R&D projects, share (re)purchase programs, and other uncommitted contingent activities find their public forum in press releases that are carefully worded to avoid class action lawsuits by disgruntled shareholders.

The important point is that growth per se does not always create value for the common stock owners. As John Burr Williams wrote (1938: 419): That a non-growing industry can be profitable is shown. and that a fast-growing industry can be unprofitable is shown.

An important distinction is the difference between reported accounting value (book value or net worth per share) and intrinsic economic value (discounted future dividends per share). Book value does not reflect inflation and obsolescence, nor does it include intangible assets such as franchises and technological prowess resulting from R&D expenditures. In addition, book value per share is merely a mechanical screening ratio set at an arbitrary cutoff point which does not reflect judgment and does not reliably distinguish between underpriced bargain stocks and fairly-priced junk stocks.

Intrinsic economic value of an operating enterprise is appraised by use of discounted cash flow techniques in the so-called dividend discount model originated by John Burr Williams. He made allowance for both dividends and future selling price. He also explains how the transposed dividend discount model can be used to determine what the market as a whole is expecting, and this can be compared with the investor’s expectation.

As John Burr Williams (1938: page 466) wrote: in other words, Investment Analysis usually measures the relative rather than the absolute value of any stock, and leaves to the economist the broad question of whether stocks in general are selling too high or too low. From the point of view of this book, which is concerned with absolute rather than relative value.

According to Williams (1938), the four basic factors needed to appraise the intrinsic value of an operating enterprise and thus its common stock equity. two economy-wide factors and two company-specific factors. The economy-wide factors are general price level inflation and the real interest rate. The company-specific factors are the estimated future net cash distributions to the stockholders and the discount rate or rates applied to those cash receipts. For foreign companies, a fifth factor may be required: the currency exchange rate, which is discussed at length by Williams (1954). This is important enough to justify a table to repeat it for emphasis.

Factors of Intrinsic Economic Value