Finding the fair value of a stock is basically checking what a company is genuinely worth instead of going by market hype. When an investor compares a company’s true earning power with the price shown on the screen, they are able to spot whether the stock is undervalued, overpriced, or fairly priced.
Read further to know how to find the Fair Value of a Stock using simple valuation methods such as DCF, PE, EPS formulas, and book value, so an investor can judge a stock’s worth with clarity and make safer, more confident investing decisions.
What is the Fair Value of a Stock?
The fair value of a stock is the estimated intrinsic value of a company’s shares based on its fundamentals, such as earnings, year-on-year growth rate, and financial health, rather than the market price seen on the screen.
The investors usually use the fair value of a company as a benchmark to decide if its stocks are undervalued or overvalued by comparing them to the current market price. It helps the investors to keep their decisions sharp, informed, and free from market drama.
Market Price vs Fair Value
The table below provides an understanding of how the fair value of a stock differs from its market price.
| Aspect | Market Price | Fair Value |
| Meaning | The market price is the current price at which a stock market asset is actually traded, bought, or sold | It is the price at which an asset could be traded between knowledgeable, willing parties |
| Determination | A stock’s price is based on the current market forces of demand and supply. | It is based on the fundamental analysis, future assumptions, and models |
| Volatility | It is highly volatile, as it fluctuates along with the market conditions | It shows lower volatility because it’s driven by longer-term factors |
| Usage | It is used in real-time transactions, such as real estate or certain securities | It is used in financial reporting and impairment tests |
Why Fair Value Matters to Investors
- Identifies undervalued stocks: When a stock’s fair value is higher than its market price, it is considered undervalued, suggesting it could be a good time to buy, as the stock value might have the potential to increase.
- Indicates overvalued stocks: If a stock’s market price is higher than its fair value, it is considered overvalued. The investors might choose to sell or avoid such stocks, as they may go through a downward price correction.
- Supports value investing: This aligns with the idea of purchasing stocks that trade below their true worth, which forms value investing.
- Helps in assessing a company’s true worth: The fair value is an estimate of a company’s intrinsic value based on its assets, earnings, and market conditions, which provides a real picture than just the current market price.
Methods to Calculate the Fair Value of a Stock
Check out the different methods to calculate the fair value of a stock, which might be used by a company or an investor.
Discounted Cash Flow (DCF) Valuation
The Discounted Cash Flow (DCF) approach works out a company’s fair value by bringing its projected future cash flows back to their present value. This method is generally seen as dependable for businesses with steady, predictable cash flows.
DCF = CF1/(1+r)^1 + CF2/(1+r)^2 +…+ CFn/(1+r)^n
Where,
- CF1 = Free Cash Flow for a year
- r = Discounted rate
- n = Number of years in the period
PE Ratio Valuation Method
The Price-to-Earnings (P/E) ratio helps judge whether a stock looks expensive or cheap by comparing its earnings with those of similar companies. A company’s P/E is weighed against its own past levels, the industry, or a benchmark index to see if it’s trading above or below what’s typical.
It is calculated as,
P/E Ratio = Market Price per share / Earnings per share (EPS)
Fair value = EPS x Benchmark P/E Ratio
EPS-Based Benjamin Graham Formula
The EPS-based Benjamin Graham formula provides a maximum price a defensive investor would pay, based on the company’s earnings per share (EPS) and book value per share (BVPS), while complying with certain safety limits on P/E (max 15) and P/B (max 1.5) ratios.
It is calculated as,
Graham Number = √22.5 x EPS x BVSP
Book Value / Net Asset Valuation
The Net Asset Value (NAV), also Book Value, calculates the fair value of a company from its balance sheet. It works out the book value by taking the company’s total assets and reducing them by its total liabilities.
How is it calculated?
Book Value = Total Assets – Total Liabilities
Book Value per share (BVPS) = Book Value/ Outstanding Shares, or
BVPS = Shareholders’ Fund/Outstanding Shares
Example: Fair Value Calculation in Step-by-Step Method
Let’s understand with an example how investors find the fair value of a stock by using the DCF method to estimate a stock’s fair value by discounting the company’s future free cash flows with its Weighted Average Cost of Capital (WACC).
Let’s analyse ZXD Ltd. to find its fair value. The WACC of the company is 5%, so that’s the discount rate. Based on the company’s financial outlook, the estimated free cash flows for the coming five years are as follows:
| Year | Free cash flow |
| 1 | ₹1 Cr |
| 2 | ₹1 Cr |
| 3 | ₹4 Cr |
| 4 | ₹4 Cr |
| 5 | ₹6 Cr |
Next, applying the DCF formula, the present values of these cash flows come to:
| Year | Free cash flow | Discounted Cash Flow |
| 1 | ₹1 Cr | ₹0.95 Cr |
| 2 | ₹1 Cr | ₹0.91 Cr |
| 3 | ₹4 Cr | ₹3.46 Cr |
| 4 | ₹4 Cr | ₹3.29 Cr |
| 5 | ₹6 Cr | ₹4.70 Cr |
| Total | ₹13.30 Cr |
Now, let’s assume the company has 1 Cr of outstanding shares.
Fair Value Per Share = ₹13.30 Cr/1 Cr shares = ₹13.30 per share
So, if the company’s stocks are trading at ₹10, it’s undervalued, and if the stocks are trading at ₹18, it’s overpriced.
Tools to Check the Fair Value of Stocks Online
The investors might use stock market AI tools, like Stoxo, to check the fair value of stocks in a simple and fast way. It evaluates a company’s fundamentals, financial strength, and delivers insights backed by SEBI-registered analysts, through natural commands.
Factors to Check Along With Fair Value
- Financial and company factors: It is important to evaluate a company’s fundamentals, such as earnings strength, cash flow, debt levels, assets, growth potential, management quality, liquidity, and depreciation, as it helps in understanding how stable a company is before trusting its fair value.
- Economic and market factors: The investors should be mindful of the market sentiment, interest rate changes, inflation, global events, regulations, and tech shifts, which can directly affect a company’s performance and valuation.
- Valuation and analysis factors: The investors should use methods such as peer comparisons, replacement cost checks, exit price estimates, and a risk-appropriate discount rate to build an accurate sense of the company’s worth.
Common Mistakes in Fair Value Calculation
- Relying on Unreliable Financials / Inadequate Data: If the investors use outdated or inaccurate financial data, it weakens the entire valuation, so verified statements and proper due diligence are non-negotiable.
- Making Unrealistic Projections and Assumptions: If the investors stay overly optimistic, and the growth forecasts or assumptions are not backed by history or market realities, valuations can inflate, creating a misleading fair value.
- Using an Incorrect Discount Rate or Wrong Multiples: A mismatched discount rate or unrelated peer multiples can distort the present value calculations and lead to faulty conclusions about a stock’s worth.
- Ignoring Non-Recurring Items and Company-Specific Risks: If the investors fail to remove the one-time events or account for unique risks, it skews true earning power and weakens the valuation’s accuracy.
Conclusion
The fair value of a stock helps investors in looking past the market noise and judging a company by its real earning power. The investors can identify whether a stock is undervalued or overpriced by using methods such as DCF, P/E, EPS-based valuation, and book value, which brings clarity, confidence, and discipline to long-term investing, making decisions more grounded and less emotional.
FAQs
The fair value of a stock can be calculated by estimating a company’s true worth based on its earnings, cash flows, growth rate, and assets, which helps in comparing the intrinsic value with the current market price to judge whether the stock is undervalued or overpriced.
The accuracy of a valuation method depends on the company’s business model, stability, and the availability of reliable financial data. The DCF is usually considered a detailed method because it looks at future cash flows and discounts them to the present value. However, the P/E, EPS-based formulas, and book value methods also add clarity when used together.
The fair value remains consistent during market volatility because it is built on fundamentals rather than price swings. While the market prices may jump around, the intrinsic value changes more slowly, helping the investors to avoid emotional decisions and focus on long-term earnings strength.
Yes, the retail investors can calculate the fair value using simple formulas like DCF, P/E-based valuation, EPS-based Graham numbers, or book value. With basic financial data, even a beginner can estimate whether a stock is undervalued or overpriced, and tools like Smart-Investing, TIKR, and Yadnya make the process even easier.
The margin of safety in fair value calculation is the difference between a stock’s intrinsic value and its current market price, expressed as a percentage, for example, 20-30%. This buffer protects the investors from errors in assumptions, market uncertainty, and sudden changes in financial performance, helping to reduce potential downside risk.
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