Stock Value Based on FCF Valuation Model

If the per-share value of equity obtained from the model is lower than the share price, the stock is overvalued.

If the per-share value of equity obtained from the model is higher than the share price, the stock is undervalued.

If the per-share value of equity obtained from the model is the same as the share price, the stock is fairly valued.

Question

Which of the following situations most likely results in a stock being overvalued?

1. When the market price is higher than the intrinsic value.
2. When the market price is less than the intrinsic value.
3. When the market price is equivalent to the intrinsic value.

Solution

The correct answer is A. 

A stock is overvalued when the market price is higher than the intrinsic value.

B is incorrect. When a stock’s market price is lower than its intrinsic value, the stock is considered undervalued.

C is incorrect. When the market price is equivalent to the intrinsic value, the stock is considered fairly valued.

Reading 24: Free Cash Flow Valuation

LOS 24 (m) Evaluate whether a stock is overvalued, fairly valued, or undervalued based on a free cash flow valuation model.