Fair Value

What Is Fair Value?

Fair value is a way of describing what something is reasonably worth. It is not a fixed number that appears on a price screen. It is an estimate that analysts, accountants, and investors reach using judgment, data, and models. The term is used in two related ways. In investing, it usually refers to an estimate of a stock's or other asset's intrinsic worth, which can be compared with its market price to judge whether the market may be pricing it above or below that estimate. In accounting, it refers to a formal measurement standard for reporting assets and liabilities on financial statements.

How Fair Value Is Estimated

Investors often build a fair value estimate from a company's fundamentals. Common approaches include:

• discounted cash flow (DCF) analysis, which projects future cash flows and discounts them back to a present value
• comparable company analysis, which compares valuation multiples with similar businesses
• Asset-based approaches, which look at the value of what a company owns less what it owes

Each method depends on assumptions about growth, risk, and interest rates. Small changes in those assumptions can produce very different results, so fair value estimates are best read as ranges rather than precise figures.

Fair Value in Accounting

Under accounting standards such as ASC 820 in the United States and IFRS 13 internationally, fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. Some assets, such as certain investments, are reported at fair value on a regular basis, a practice related to mark-to-market accounting. Accounting standards also rank the inputs used in these measurements by reliability, from observable market prices at the top to internal company models at the bottom.

Why It Matters to Investors

Fair value gives investors a reference point. Comparing market price with an estimated fair value is one way to think about valuation, though no estimate is certain. Estimates can be wrong, prices can stay away from them for long periods, and intrinsic value itself is uncertain. Reading a fair value figure together with its assumptions is more useful than treating it as a verdict.