Question

Is it better for a firm's actual stock price in the market to be under, over, or equal to its intrinsic value? Would your answer be the same from the standpoints of stockholders in general and a CEO who is about to exercise a million dollars in options and then retire? Explain.

Answer 1

Intrinsic value of a stock- It is a true or fair value of a stock. This is the actual value of a stock that is derived through fundamental analysis.

Equilibrium- A stock should be fairly priced and should trade equal to its intrinsic value or near its intrinsic value.

Undervalued- If a stock is trading below its intrinsic value, it is called, "Undervalue stock". Undervalued stocks are good to buy for long term investment purpose. If stock is in oversold zone, it is a good buy

Overvalued- If a stock is trading above its intrinsic value, it is considered "Overvalued stock". Overvalued stocks are good to sell. When stock is in overbought condition, it should not be bought further because profit booking (selling) may be seen in the stock.

Management goal is to maximize the stock's intrinsic value. Shareholders will want undervalued shares.

If a CEO wants to sell his holding, he should see whether the stock is overvalued or undervalued, if stock is overvalued then only he should sell his holdings because he will get good profit. If the stock is undervalued, he should wait for some time. A CEO who has the holding will want a higher current price of the stock.