Fair Value vs. Market Value: Decoding the Appropriate Benchmark in Valuation
Mr. Lakshman S.
Mr. Lakshman S. is a Civil Engineering professional with 35+ years of experience, including 14 years overseas in construction, contracts, and project management. Since 2016, he has been working in property valuation and is a Registered Valuer with both IBBI and the Income Tax Department. He is currently based in Namma Bengaluru and brings deep expertise in Land & Building valuations.
Valuation is at the heart of modern finance, corporate transactions, and investment decisions. Whether an investor is analyzing a stock, a company is raising capital, or regulators are scrutinizing financial statements, the question often arises: What is the true worth of the asset? Two concepts that frequently surface in this context are Fair Value and Market Value. Although often used interchangeably in casual contexts, they represent fundamentally different approaches to determining value. Understanding the nuances between the two benchmarks is critical for professionals, regulators, and stakeholders alike.
Defining the Concepts
Market Value
Market value refers to the price at which an asset would change hands between a willing buyer and a willing seller in an open, competitive market. It reflects the interaction of supply and demand at a given point in time. Market value is observable, dynamic, and often influenced by external factors like investor sentiment, liquidity, economic conditions, and market efficiency.
For example, the price of a listed company’s share on a stock exchange is its market value. The value may fluctuate daily, not necessarily because the company’s intrinsic fundamentals change, but rather due to broader market sentiment or short-term news events.
Fair Value
Fair value, on the other hand, is a broader, principle-based measurement that captures the rational and unbiased estimate of an asset’s worth. It incorporates not only observable market inputs but also assumptions, professional judgment, and modeling techniques in contexts where markets are imperfect or inactive.
The International Financial Reporting Standards (IFRS) and Indian Accounting Standards (Ind AS) define fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Unlike market value, fair value does not require an actual transaction to take place.
For example, in valuing a private company that is not listed on the stock exchange, professionals use discounted cash flow (DCF) methods, comparable company multiples, or precedent transactions to arrive at a fair value, even though there is no readily available market price.
Key Differences Between Fair Value and Market Value
Parameter | Fair Value | Market Value |
Basis | A rational estimate may include modeling, assumptions, and subjective judgment. | Determined by actual transactions and demand-supply forces in the market. |
Applicability | Common in accounting, litigation, mergers, and private transactions. | Common in real estate, stock markets, and open auction scenarios. |
Market Activity | It can be applied even where no active market exists. | Requires an active market with observable prices. |
Volatility | Relatively stable, since based on fundamentals and assumptions. | Highly volatile; fluctuates with market trends and investor sentiment. |
Regulatory Usage | Used under IFRS, Ind AS, and US GAAP for financial reporting. | Used for stamp duty, taxation, and transactional purposes. |
Illustrative Examples
1. Real Estate Example
Suppose a residential property is located in a developing area.
a. Its market value might be ₹1.2 crore because that is the price buyers in the market are currently willing to pay.
b. However, its fair value may be estimated at ₹1.5 crore if future infrastructure projects, growth potential, and comparable sales are factored in.
Here, the market reflects current sentiment, while fair value considers future potential and intrinsic worth.
2. Equity Investment Example
Imagine a company’s share trading at ₹500 on the stock exchange. This price represents the market value—determined by what buyers and sellers agree upon in the marketplace at that moment.
a. This price represents the market value—determined by what buyers and sellers agree upon in the marketplace at that moment.
b. After performing a discounted cash flow analysis, an analyst estimates the company’s intrinsic worth at ₹650 per share. This becomes its fair value, reflecting long-term earnings potential rather than short-term price action.
3. Insolvency and Bankruptcy Cases
Under India’s Insolvency and Bankruptcy Code (IBC), resolution professionals must determine the fair value and liquidation value of assets.
a. Fair value helps creditors understand what the company is worth under normal conditions.
b. Market value may be significantly lower due to distress sale conditions, such as when bidders know the seller is under compulsion.
Practical Implications
1. For Investors
Investors must distinguish between these values to avoid misjudging opportunities. Buying an asset only at market value might expose one to irrational bubbles or pessimism-driven crashes. In contrast, fair value provides a more balanced anchor to decide whether an asset is undervalued or overvalued. Legendary investors like Warren Buffett consistently emphasize buying at a discount to intrinsic or fair value rather than blindly following market quotations.
2. For Businesses
Companies rely on fair value for financial reporting under accounting standards, ensuring transparency for stakeholders. For instance, derivatives, employee stock options, and intangible assets are measured at fair value rather than market value because an active market does not always exist for such instruments.
3. For Regulators
Regulators and auditors prefer fair value to maintain consistency and avoid manipulative practices. Market value alone may misrepresent financial position if markets are highly volatile or illiquid. That is why Ind AS and IFRS mandate fair value disclosures in financial statements.
4. For Legal and Tax Purposes
In disputes such as shareholder exits or divorce settlements, courts often rely on fair value to ensure equitable distribution, since market prices may not always represent a just benchmark. Conversely, tax authorities may adopt market value for calculating stamp duty or capital gains, as it represents an immediate, realizable figure.
Challenges in Application
- Subjectivity in Fair Value
Estimating fair value requires assumptions about cash flows, discount rates, or market comparables. This can introduce bias, and different valuers may arrive at different numbers for the same asset. - Volatility of Market Value
Market value, while seemingly objective, can be distorted by speculative trading, economic cycles, or temporary liquidity crunches. Assets may appear significantly undervalued or overpriced in such circumstances. - Regulatory Overlaps
Certain frameworks demand fair value reporting, while taxation authorities may stick to market value, creating confusion for businesses and investors who must reconcile the two.
Striking the Balance
Neither benchmark can be dismissed outright. Market value provides real-time insight into what an asset can fetch today, while fair value gives a more reasoned perspective on long-term worth. A balanced approach often involves comparing both:
- If market value > fair value, it may signal overvaluation.
- If market value < fair value, it could represent a buying opportunity.
For example, during the COVID-19 market crash in 2020, many fundamentally strong companies were trading well below their fair value. Investors who recognized the discrepancy benefited significantly when markets recovered.
Conclusion
The debate between fair value and market value concerns not superiority but rather applicability within specific contexts. Market value captures the pulse of the market in real time, while fair value seeks to measure intrinsic worth through rational assumptions. For professionals engaged in valuation—whether in finance, accounting, or legal practice—the key lies in identifying which benchmark best suits the situation.
When assessing an investment or asset, one must remember: market value tells you what you would pay today, while fair value tells you what it is truly worth. Recognizing the difference is what separates a speculative decision from an informed one.
For any clarifications or queries, please feel free to reach out to us at admin@fintracadvisors.com
Disclaimer
The content published on this blog is for informational purposes only. The opinions expressed here are solely those of the respective authors and do not necessarily reflect the views of Fintrac Advisors. No warranties are made regarding this information’s completeness, reliability, or accuracy. Any actions taken based on the information presented in this blog are solely at the reader’s risk, and we will not be liable for any losses or damages resulting from its use. It is recommended that professional expertise be sought for such matters. External links on this blog may direct users to third-party sites beyond our control. We do not take responsibility for their nature, content, or availability.
