Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014

(ISSN -2347-5005)

Analysis of Gap in Intrinsic and Market Value of

Companies
Chitra Bhatia Arora

Rajesh Shaw

School of Management
Apeejay Institute of Technology, Greater Noida

Angel Broking Ltd.

New Delhi

_____________________________________________________________________________________________________________________

Abstract: Wide gap between Intrinsic and market value of the company indicates existence of inefficiencies in the
market. Empirical results and graphs indicate that intrinsic value is often overlooked by irrational investors,
which further increases inefficiency in the market. Prices, sales, P/E ratios are normally distributed. Multipliers
explain the change in intrinsic value more appropriately than other factors like sales. Fragile expectations of
investors derive market price away from intrinsic value, both at recovery and boom phase of stock market.
Key Words: Intrinsic Value, Market Value, Inefficiency
_____________________________________________________________________________________________
I INTRODUCTION
It is constant practice by analysts in the market to identify the intrinsic value of the company for long term
investment. The efficient market reduces the gap between two values. Intrinsic value is derived from fundamentals
of the companies that is sales, profitability, earning per share and operating efficiency. Market price of the shares
which is dependent on demand and supply of the shares in the market. It may be affected by key market players
operational in the market. Identification of such players is herculean task for common investors. This also derives
speculation in the market and often the reason of overvaluation and undervaluation of the shares. It has been a
constant debate among researchers to identify which value to be considered for making investment decision.
Moreover, what pushes the market value away from intrinsic value of the share? To calculate intrinsic value has
been a challenging task for experts. Behavioural finance theories say that in long run market prices cannot stay away
from its equilibrium price/intrinsic value. In cobweb structure of price movement arbitrators will bring the prices to
equilibrium price indicating damped oscillations. This behaviour of price also indicates that investor has to be
cautious while investing and should not overlook the fundamentals of the company. The share is under- priced when
intrinsic value of the share is greater than the market price. Analyst advice pick of such stock in the market for long
run. In the similar manner, share is tagged over-priced when the market price is greater than the intrinsic value of the
share. Intrinsic value is the present value of future gains in the market. Expected gains that are dividend and capital
gain which depend on realised events and holding period of the stock by the investor. Market price on the other hand
is combination of discounted value of expected fundamentals and irrational expectations of investors in the market.
In perfect market Fama [1] role of sophisticated investor nullifies the gap between market price and intrinsic value
of the stock.The price of the share is basically derived from the earnings of the share. EPS (Earning per Share)
calculates the rate of return on the equity. Other vital decision of management like distribution of dividend also
impacts the returns of equity holders. Walter Model as well as Gordon model of calculating equity price indicates

30

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

that if rate of return is high in future projects of the company reinvestment of profit will maximise the value of
equity, whereas, vise-versa in such situation may bring the equity price down.
In this paper intrinsic value is calculated on the basis Ben Grahams formula for calculating intrinsic value. V =
EPS*(8.5+2G), EPS (12 month)
EPS=Earning Per Share =Net Profit after Interest and Tax/Outstanding Shares
8.5 = P/E base for a no growth company
G = reasonably expected 7 to 10 year growth rate
II REVIEW OF LITERATURE
Behavioural finance theory explains the behaviour of price through chartist theory, fundamental theory, Random
Walk Model and Efficient Market Hypothesis. If chartist theory prevails which claims that past prices explains the
current and future price then Random Walk theory rules out. Whereas, RWM propounds that stock market is a
speculation and nothing is predictable. Fama [2] in his Ph.D thesis discussed Random Walk Model theory in details.
He propounded a thought that if RWM prevails in the market then chartist theory and fundamental theory cannot
stand. Many empirical experiments in the paper supported that successive changes in the prices are independent. He
further stated that major stock exchanges are good example of efficient market where large number of rational profit
maximizers actively competing with each other. In an efficient market at any point in time the actual price of
security will be a good estimate of its intrinsic value.
Ja Ryong Kim [3], stated that stock price is the sum of realized events and price of expectation of future events,
which influence companys future cash flow. He found multiplier more effective to calculate intrinsic value than
discounted cash flow .PriceStock= Price (Realised Events)+Price (Expectation) which when elaborated give
equation Price Stock=Price (Realised Events)+ Price (Expectation)+Price (Irrational Expectation). Price (Realised
Events) is price based on past events (accounting information), Price (Expectation) based on market or company
fundamental. Price Irrational Expectation based on (rumour, discontinuous information. Price Intrinsic Value= Price
(Realised Events)+ Price(Rational Expectation). In his paper he assumed that Price Irrational Expectation=0. The
most basic valuation model is book value. Book value estimates the price of realised events, it fails to incorporate
information on expectation, thereby generates large difference between stock price and estimate.

III OBJECTIVES
The study focuses on following research questions: (i) Does gap exist between Intrinsic and Market value of the
stock? (ii) Which factors appropriately explains the change in intrinsic value? (iii) Does Intrinsic value of stock
explain the change in the market price of the stock?

IV EMPIRICAL ANALYSIS

31

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

A. Tables
TABLE I
DESCRIPTIVE STATISTICS OF TATA MOTORS
TATA Motors Ltd

Intrinsic Value

Market Value

Sales

Net Profit

P/E Ratios

Mean

574.76

219.44

127981.69

6541.81

4.91

Standard Error

187.83

39.17

21964.55

2872.08

1.72

Median

398.75

211.77

122127.92

9220.79

4.67

(t value)

0.93

0.195

0.266

0.93

0.13

Mode

N/A

N/A

N/A

N/A

N/A

Standard Deviation

419.99

87.58

49114.24

6422.16

3.83

Sample Variance

176398.09

7670.36

2412208782

41244221.82

14.73533

Kurtosis

4.36

1.36

-2.08

-1.04

0.85

Skewness

2.051

-0.207

0.18

-0.61

1.04

From the above table following inferences maybe drawn(i)K< 3 in all cases that is intrinsic value, market-value,
sales, net profit and P/E ratios which is platykurtic distribution, flatter than a normal distribution with a wider peak.
The probability of extreme values is less than for a normal distribution;(ii) Skewness of all variables lies between +1
and -1 showing symmetric distribution;(iii) difference between mean and median is not significant in any of the
above case; (iv) Standard deviation of intrinsic value is high in comparison to market value which is obvious as SD
of fundamental values are high; overall the five years data of Tata Motors are normally distributed.
TABLE II
DESCRIPTIVE STATISTICS OF HDFC BANK LTD.
HDFC Bank Ltd

Intrinsic Value

Market Value

Sales

Net Profit

P/E Ratios

Mean

469.84

466.96

28401.81

4295.28

12.736

Standard Error

107.83

65.83

4463.77

824.25

4.475

Median

483.87

454.08

24628.38

4017.69

6.11

(t value)

0.13

0.28

0.36

0.33

1.48

Mode

N/A

N/A

N/A

N/A

N/A

Standard Deviation

241.1345

147.20

9981.298

1843.08

10

Sample Variance

58145.85

21668.16

99626320

3396959.97

100.159

Kurtosis

-1.56

-0.371

-0.92

-0.749

-3.13

Skewness

0.238

-0.179

0.88

0.535

0.634

Above table shows that distribution of data is symmetrical and normal. Though standard deviation is high which
indicates fluctuation in prices, especially SD of intrinsic value is higher than the market value.

TABLE III
DESCRIPTIVE STATISTICS OF DLF LTD.

32

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)
DLF Ltd

Intrinsic Value

Market Value

Sales

Net Profit

P/E Ratios

Mean

96.676

258.606

8893.82

1939.29

32.062

Standard Error

35.483

26.152

530.618

671.46

6.865

Median

67.6

237.37

9560.57

1638.02

30.71

Mode

#N/A

#N/A

#N/A

#N/A

#N/A

Standard Deviation

79.344

58.478

1186.499

1501.43

15.35239

Sample Variance

6295.50

3419.78

1407781.502

2254294.183

235.696

Kurtosis

4.021

-2.978

-2.905

3.6223

-0.546

Skewness

1.937

0.427

-0.532

1.794

-0.0061

(t value)

TABLE IV
DESCRIPTIVE STATISTICS OF BHARTI AIRTEL LTD.
Bharti Airtel Ltd

Intrinsic Value

Market Value

Sales

Net Profit

P/E Ratios

Mean

174.362

338.656

28401.81

4295.28

12.736

Standard Error

60.501

8.089

4463.772

824.252

4.475

Median

168.49

454.08

24628.38

4017.69

6.11

Mode

#N/A

#N/A

#N/A

#N/A

#N/A

Standard Deviation

135.285

147.20

9981.298

1843.08

10.007

Sample Variance

18302.19

21668.16

99626320

3396959.97

100.159

Kurtosis

0.072

-0.371

-0.92432

-0.749

-3.129

Skewness

0.831

-0.1791

0.88049

0.53581

0.6343

(t value)

TABLE V
DESCRIPTIVE STATISTICS OF ACC LTD.
ACC Ltd

Intrinsic Value

Market Value

Sales

Net Profit

P/E Ratios

Mean

560.29

1048.77

9884.92

1211.876

17.01

Standard Error

45.317

108.46

664.08

98.013

2.59

Median

500.14

1090.58

10237.19

1081.73

16.51

(t value)

1.327

0.38

0.53

1.327

0.196

Mode

#N/A

#N/A

#N/A

#N/A

#N/A

Standard Deviation

101.33

242.52

1484.94

219.16

5.794

Sample Variance

10268.37

58820.50

2205073.09

48032.76

33.571

Kurtosis

1.061

-0.113

-2.93

1.059

0.487

Skewness

1.385

-0.817

-0.298

1.38

-0.789

Standard Deviation is high in all cases which are obvious as prices change every second in the market which derives
the prices away from equilibrium moreover, yearly average prices moves or drifts a part from previous years price.
Kurtosis and Skewness is within range indicating normal distribution of prices, sales, market value and net profit.

TABLE VI

33

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)
REGRESSION RESULTS (Market value): MktVt=0+1IntVt
Company

Intercept

R2

ACC Ltd

2137.69

-1.943

0.65

5.81

(t)

4.67

-2.41

Bharti Ltd

-1385.97

4.61

0.37

1.83

(t)

-1.20

1.35

DLF Ltd

215.55

0.445

0.365

1.72

0.29

1.26

0.052

0.164

(t)

5.30

1.31

HDFC Bank Ltd

623.04

-0.33

(t)

4.07

-1.12

Tata Motors Ltd

246.75

-0.047

(t)

3.065

-0.405

From the above results following inferences are drawn (i) the above model is not the best fit ,as intrinsic value does
not explain the change in market price ;(ii) intercept is significant in all cases except Bharti this indicates that fixed
variable give significant effect on market price of the share like fundamentals of the company;(ii) Coefficient of
market price is significant in only one case that is ACC ltd, this result is obvious as market price is determined by
the demand and supply of shares and intrinsic value depends on the fundamentals of the company. These results
further raise the question mark on the efficiency of the market, where investor is considered to form expectation on
the bases of the fundamentals of the company. New set of information according to Fama brings adjustment in the
price. The first impact will be on intrinsic value of the stock . this further indicates strong impact on market price but
above results contradicts the theory of finance.
TABLE VII
REGRESSION RESULTS (Intrinsic value): IntV= 0+1Sales
Company

Intercept

R2

ACC ltd

893.23

-0.033

0.243

0.96

(t)

2.613

-0.98

Bharti Ltd

568.57

-0.006

0.86

18.87

(t)

6.025

-4.34

DLF Ltd

-277.53

0.042

0.395

1.96

(t)

-1.03

1.40

HDFC Bank Ltd

811.52

-0.079

0.369

1.759

0.05

0.159

(t)

2.941

-1.326

Tata Motors Ltd

820.31

-0.0019

(t)

1.26

-0.398

Above results indicate that above model is not the best fit model as sales does not explain the changes in the intrinsic
value . (i)Coefficient of intercept is significant in three out of five cases that indicates that other fixed factors
provide greater impact on the intrinsic value of the stock; (ii) Coefficient of sales is significant in one case that is
Bharti Ltd, which indicates that in most cases change in sales does not bring significant change in the intrinsic value,
the result is surprising as revenue is the main determinant of efficiency of the company.

34

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

TABLE VIII
REGRESSION RESULTS (Intrinsic value): IntV= 0+1P/E (Price/Earning Ratio)
Company

Intercept

R2

ACC Ltd

832.99

-16.032

0.84

15.788

(t)

11.61

-3.97

Bharti Ltd

334.41

-5.31

0.81

12.78

(t)

6.17

-3.5748

DLF Ltd

237.97

-4.40

0.72

7.99

(t)

4.37

-2.827

HDFC Bank Ltd

743.01

-21.44

0.79

11.45

0.423

2.202

(t)

7.531

-3.384

Tata Motors Ltd

924

-71.186

(t)

3.216

-1.48

Above table indicates that given model is the best fit and explains the change in the intrinsic value of the stock. This
further clears the thought that only market price does not explain change in intrinsic value but ratio of price and
earning is the true parameter of efficiency of the company, maybe operational efficiency and leverage maximises the
earning of shareholders and this brings change in intrinsic value of the share. (i) Coefficient of intercept is
significant in all the cases which indicates the great influence of other factors on intrinsic value ; (ii) coefficient of
Price/Earnings ratio is significant indicating significant impact of change in P/E on Intrinsic value. Moreover, all
coefficients are negative, indicating reverse impact of increase and decrease of P/E ratio. This may be justified as
increase in P/E may be due to increase in price or reduction of earnings of shareholder, in both cases intrinsic value
will come down.
B. Charts of Intrinsic and Market Value

Fig. 1 ACC Ltd.

35

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

Fig. 2 Bharti Ltd.

Fig. 3 DLF Ltd

Fig. 4 TATA Motors Ltd.

36

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

Fig 5 HDFC Bank Ltd

In the above figure intrinsic value was higher than market value from 2009 to 2011. Intrinsic value went below
market value in 2012, this further indicates that in recovery phase of the market , market value generally shootsup.
Charts indicate that in all cases market value is higher than intrinsic value of the stock except Tata Motors from
2009 to 2013. This may be inferred that Tata Motors is undervalued and good buy for long term investor. In ACC,
Bharti and DLF the gap between market and intrinsic value widened from 2009 to 2013 which indicates that traders
are bullish on these stocks whereas in Tata Motors the gap was huge in year 2011 indicating huge change in the
structure of the company. Investors are not bullish on Tata Motors but situation seems to be changing in year 2013.
V FINDINGS
1.

There is wide gap between intrinsic and market price, which raises doubt on the efficiency of the market or
maybe new dimension in the model of intrinsic value is required which can bring intrinsic value near market
value.

2.

Intrinsic value fails to explain change in market price which further indicates existence of irrational expectation
of investor in the market. This further widens the gap between intrinsic and market price.

3.

Yearly average prices, sales and profitability of the stock of the company are normally distributed. This is also
an indication of less volatility in the given variables or maybe the result would have been different if daily
prices are taken.

4.

In stock recovery phase or at boom period market prices are generally higher than intrinsic value due to
increasing expectation of investors. High expectation increases demand and pushes market prices away from
its intrinsic value. This also indicates herd behaviour of investor in the market.

REFERENCE
[1] Eugene F. Fama (1975), Efficient Capital Markets: A Review of Theory and Empirical work ,The Journal of Finance, Vol 25, No 2, Black
Well American Finance Association. May 1975.
[2] Eugene F. Fama, The Behaviour of Stock Market Prices, The Journal of Business, Vol. 38, No. 1 (Jan., 1965), pp. 34-105, The University
of Chicago Press
[3] Ja Ryong Kim, Measuring the Intrinsic Value, The University of Edinburgh Business School.

37

Arora & Shaw, Apeejay - Journal of Management Sciences asnd Technology 3 (1), June- 2014
(ISSN -2347-5005)

OTHER REFERENCES
Bruce N.Lehmann, Asset Pricing and Intrinsic Values: A Review Essay, NBER Working Paper No.38 B, Oct 1991.
Stefan Palan, The Efficient Market Hypothesis and its Validity in Todays Markets Ph.D Thesis, Aug 2004.
Eugene F. Fama, Random Walks in Stock Market Prices, Graduate School of Business University of Chicago. Paper No 16.

38