How can a company valued at $50 billion one year be worth almost nothing the next? Or how can a forgotten, "boring" company quietly triple in value while no one is watching?
The answer lies in the critical, often misunderstood, gap between valuation and value.
Simple Definition
Valuation is the price the market assigns to an asset today. It's an estimate, often driven by public sentiment, growth expectations, market trends, and hype. It is what someone is willing to pay right now.
Value (or intrinsic value) is the fundamental, underlying worth of an asset based on its ability to generate future cash and its tangible and intangible assets. It is what the asset is actually worth, independent of market noise.
Simple Example
Think of the dot-com bubble in 1999. A company like Pets.com had an astronomical valuation because investors believed it would dominate the future of e-commerce. The market priced it for perfection, and its stock soared.
Its intrinsic value, however, was near zero. The business model was fundamentally flawed, burning cash with no path to profit.
When sentiment changed, the valuation collapsed to meet its low (or non-existent) intrinsic value. The market price was high, but the fundamental worth was not.
Why It Matters
Confusing valuation with value is the single fastest way to make poor investment or business decisions. Paying $100 for an asset valued at $100 but only worth $50 is a guaranteed loss, waiting to happen.
Conversely, finding an asset worth $500 that is valued by the market at $200 is how fortunes are built.
In business operations, a high valuation can attract talent and capital, but it doesn't pay the bills. Only real, underlying value—like strong cash flows, a loyal customer base, and a defensible business model—can sustain a company long-term. Chasing valuation for its own sake leads to "growth at all costs" strategies that often implode.
Practical Insight
This distinction is the core of "value investing," an approach focused on finding assets where value is high but valuation (the market price) is low.
How do you spot the difference? Valuation is often measured by simple, relative "multiples," like a Price-to-Earnings (P/E) or Price-to-Sales (P/S) ratio. These are shortcuts and highly susceptible to market mood. A "hot" industry will get high multiples, regardless of individual company quality.
Determining intrinsic value is harder. It requires analyzing the business fundamentals. This includes:
Quantitative: Estimating all future cash the business will actually produce and discounting it back to today (a Discounted Cash Flow or DCF analysis).
Qualitative: Assessing the company's "moat" (its competitive advantage), the quality of its management, and the long-term strength of its industry.
A high P/E ratio (a high valuation) might be justified if the company's intrinsic value (its future cash flows) is growing even faster. Or, it could just be hype. The smart operator always asks: "What is the price (valuation), and what am I getting (value)?"
When those two numbers diverge significantly, that is where both high risk and great opportunity live.
Quick Summary
Valuation is the market's opinion; value is the business's reality.