Every buy or sell decision comes down to one comparison: is this share worth more than it costs? The cost is on the screen. The worth — the fair value — is the harder half, and it is where returns actually come from. This guide explains what fair value means, the three methods used to estimate it, and walks through a worked example for an Indian stock.
Fair value vs market value
Two numbers describe every share, and confusing them is the most expensive mistake in investing.
- Market value is the price a share trades at right now, multiplied by the shares outstanding. It is set by millions of buyers and sellers reacting to news, mood and momentum, and it can swing several percent in a day while the business is completely unchanged.
- Fair value is an estimate of what the business is genuinely worth — grounded in the cash it produces, the assets it owns and the profits it earns. It moves slowly, because businesses change slowly.
Market value is a fact you can read off the screen. Fair value is a judgement you have to work out.
The whole discipline rests on one observation: in the short run price and fair value wander apart, and in the long run they converge. Your edge is being able to estimate fair value independently, so you can tell an opportunity from a trap. If you want the deeper theory behind this, start with the intrinsic value of a stock — "fair value" and "intrinsic value" are the same idea in different words.
The three ways to calculate fair value
There is no single formula that fits every company. Serious analysts pick the method that suits the business, and cross-check with a second.
1. Discounted cash flow (DCF) — the gold standard
A DCF says a share is worth the cash the business will hand its owners over its lifetime, converted into today's money. You forecast the company's free cash flow for the next several years, estimate a terminal value for everything after that, and discount it all back at the company's cost of capital.
It is the most rigorous method because it values the business on what it actually produces rather than on what the market is willing to pay for it today. It is also the most demanding, because the answer depends on your assumptions about growth, margins and the discount rate. We walk through a full DCF, step by step, in how to value a company using DCF.
2. Relative valuation — fast and market-anchored
Here you apply a sensible multiple to a fundamental figure:
- a P/E multiple to earnings per share,
- a P/B multiple to book value per share,
- an EV/EBITDA multiple to operating profit.
The multiple comes from the company's own history and its closest listed peers. Relative valuation is quick and keeps you anchored to what the market actually pays for similar businesses — but it inherits whatever mispricing sits in those peers. See the P/E ratio explained for how to choose and sanity-check a multiple.
3. Asset-based valuation — the floor
For asset-heavy businesses — property, holding companies, financials — you can value the shares by summing what the company owns and subtracting what it owes. It usually sets a floor under the price rather than capturing the full worth of a going concern, but for the right business it is the most honest lens.
A worked example, step by step
Take a stable, profitable Indian company. Suppose the numbers look like this:
- Free cash flow this year: ₹1,000 crore
- Expected growth: 10% a year for five years, fading to 4% thereafter
- Discount rate (cost of capital): 12%
- Shares outstanding: 50 crore
- Net debt: ₹500 crore
Step 1 — project the cash flows. Grow this year's ₹1,000 crore at 10% for five years: roughly ₹1,100, ₹1,210, ₹1,331, ₹1,464 and ₹1,611 crore.
Step 2 — discount each year to today. Divide each year's cash flow by (1.12) raised to the number of years out. A rupee five years away at a 12% discount rate is worth about 57 paise today. The five discounted flows sum to roughly ₹4,700 crore.
Step 3 — value everything after year five (the terminal value). Using the perpetuity-growth formula, terminal value at year five is the year-six cash flow divided by (discount rate − long-term growth):
\[\text{Terminal Value} = \frac{1{,}611 \times 1.04}{0.12 - 0.04} \approx 20{,}940 \text{ crore}\]
Discounted back five years, that is worth about ₹11,900 crore today.
Step 4 — add them up and convert to equity. Enterprise value ≈ ₹4,700 + ₹11,900 = ₹16,600 crore. Subtract net debt of ₹500 crore to get equity value of ₹16,100 crore.
Step 5 — divide by shares. ₹16,100 crore ÷ 50 crore shares = ₹322 per share.
If the stock trades at ₹250, it looks undervalued on these assumptions; at ₹420, overvalued. The number is only as good as the inputs — which is the whole point of the next section.
The single-stage shortcut (and why to be careful)
If you want a rough figure in one line, the constant-growth model collapses the whole exercise into:
\[\text{Fair Value per Share} = \frac{\text{Next Year's FCF per Share}}{\text{Discount Rate} - \text{Growth Rate}}\]
It is handy for a back-of-the-envelope check. But notice how fragile it is: with a 12% discount rate, changing long-term growth from 4% to 6% lifts the fair value by a third. A one-line formula hides that sensitivity; a proper model makes you confront it.
Fair value is a range, not a point. Anyone quoting it to two decimal places is selling false precision.
The assumptions that decide the answer
Three inputs move a fair-value estimate more than anything else:
- Growth. Take it from the company's own ten-year record, not from management guidance or a hot narrative. Ask how many years the growth can realistically last.
- Margins. Assume today's peak margins last forever and you will overvalue almost anything. Fade them toward what the industry sustains.
- The discount rate. Build it up from the risk-free rate plus a premium for equity risk, adjusted for the company's size, cyclicality and debt. For most Indian large caps it lands between 11% and 14%.
Change these and the fair value changes — so the honest way to present one is a range across a conservative, a base and an optimistic case.
Don't forget the margin of safety
Because every estimate rests on assumptions that can be wrong, you don't buy at fair value — you buy below it. The gap between price and your fair-value estimate is the margin of safety, and it is what protects you when your assumptions prove too optimistic. A 25–40% discount to fair value is a common threshold. Benjamin Graham called it the three most important words in investing.
The other side of the coin: what the price already assumes
Calculating fair value tells you what a business is worth. The complementary question — often more useful — is: what growth is today's price already taking for granted? If a share is priced for 20% growth forever and the company has never grown faster than 12%, you don't need a precise fair value to know the price is doing the heavy lifting.
This "reverse" view is built into every FairStocks company page: alongside a fair-value estimate, it works backwards from the current price to show the growth and margins the market is assuming — so you can see exactly what bet you would be taking.
Do it without the spreadsheet
You can estimate fair value by hand, and it is worth doing once to understand what drives the number. But for a real decision you either build a full DCF in a spreadsheet or let a tool do the arithmetic. FairStocks builds a complete DCF and multi-method fair value for any listed Indian company straight from its filed financial statements, chooses the method that fits the business, prints every assumption next to the value it produced, and shows what today's price already assumes — a defensible fair-value range, without the blank sheet.
Fair value is the number the whole market is trying to guess. Working it out independently — and knowing how uncertain it is — is where the edge actually lives.