0:40

Now if one method of analysis that we really trust tells us that the company

is worth more than the stock price that we see, then that may be an opportunity.

In other words, if this analysis tells us the company

is worth $100 billion

instead of $50 billion,

which is its current price, well maybe we ought to buy it.

And eventually that true price will be revealed by the market.

So that's at least one reason why there's multiple

ways to assess the value of a company.

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the way we assess the value of a company is through two components.

First is book value, we'll look at the definition in a moment.

But book value is essentially the value of

the pieces of the company if you could break it up and sell it piece by piece.

In other words, if it's an airline it's the value of all the airplanes and

the luggage handlers and so on, all the physical components of that airline.

You add up all their value together, that's book value.

Where we talked about, in the first video of this module,

we talked about the value of future returns.

Remember those dollars in the future with the idea

being that dollars today are worth

a lot more then dollars in the future, but

if we add all these up over time we get a total value for all this future return.

So the fundamental approach is to say let's see what the book value is,

let's look at the value of future revenue.

Put those two together, and that's what a company's worth.

Intrinsic value is that sum we talked about before,

remember of sum over i of gamma to the i and

then that's times whatever our dividend is.

So this is if your buying the company just for

the value of the revenue that you'll get over all the future dividends,

this is what the value of the company is in that case.

But again,

there is also this book value, the value of the pieces of the company.

The company's worth at least the book value of these items

plus the intrinsic value.

Formal definition of book value is total of assets.

Now some of those assets might be things like

contracts with companies that relate to future revenue.

Those are intangible, so we subtract those and

don't count those, but we also have to count liabilities.

For instance if we have loans out on our airplanes,

we have to subtract that from the total value.

So its our physical assets, well total assets

minus the intangible, and minus liabilities.

That's the book value of a company.

Now finally, so we've talked about book value,

we've talked about intrinsic value, but what about the market.

Why don't we just let the market tell us what a company is worth?

And an actual question is well how does the market know what a company is worth?

5:06

The answer to that is that the market

is a very efficient processor of information.

Let's see if I can spell efficient.

Whenever news comes out about a company, whether it's positive or negative,

the market buys or sells as appropriate and that adjusts the price of the company.

Potentially, exactly, in an appropriate manner with regard to how does

that news affect the ability of the future of the company to generate its revenue.

6:21

Now for the kinds of things we want to be able to do in this class,

we would like to be able to anticipate moves in prices,

or find differences between fundamental value of a company, and

market price and leverage that.

Also, we might search for information in historical prices to make

directional bets, but the efficient markets hypothesis says we can't do that.

Anyways, the market says that the value of a company

is simply the number of shares outstanding times the current price of the stock.

You multiply those together and you get the market capitalization