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Value versus price

In finance, the terms price and value are not really interchangeable. An asset’s fundamental value can only be its price if well informed investors pay for it in a free and competitive market. The essence of asset valuation is to estimate how much an asset is worth using information about one or more comparable assets whose current market price we know. By the law of one price, which is enforced through arbitrage, if two assets are equivalent they will tend to have the same market price.

Value therefore comes from fundamentals which represent the capacity of the asset to generate and grow cash flows. Analysts determine this by an intrinsic valuation process which looks at projected cash flows from the asset and discounting the same using a risk adjusted weighted average cost of capital. Fundamental analysts attempt to estimate value by a thorough analysis of financial statements and accounting data like price-to-earnings (P/E) ratios, sales or profits growth rates, dividend yields , the prevailing rates of interest and other parameters.

The essence of value is that it comes from a company’s earning power evidenced by what is happening within the corporation. Such information is what causes cash flows to move and risks to be examined closely. This information is what will influence the value of the asset. Fundamental analysis looks at the intrinsic value of a company and its long-term viability.