How to Calculate Fair Value
Fair value is a stock's intrinsic worth, justified by its fundamentals rather than by sentiment. There is no single formula, but several proven methods. Here are the six most important, each with its formula, when it fits and a free calculator.
There is no single formula. These six proven methods each estimate intrinsic worth from the fundamentals. The robust approach is to combine several rather than rely on one.
1. Discounted Cash Flow (DCF)
A company is worth the sum of its future free cash flows, discounted back to today. The most thorough method when cash flows are reasonably predictable.
Value = Σ FCFₜ / (1+r)ᵗ + terminal value2. Earnings Multiple (P/E)
Fair value ≈ earnings per share × a fair P/E. Fast and intuitive for stable, profitable companies.
Fair value = EPS × fair P/E3. Graham Formula
Benjamin Graham's conservative rule of thumb for a fair maximum price, good as a cautious anchor.
V = EPS × (8.5 + 2g) × 4.4 / Y4. Peter Lynch Formula
A fair P/E roughly equals the growth rate. Fits growing quality companies.
fair P/E ≈ growth + dividend yield5. Dividend Discount Model (DDM)
A stock is worth the present value of all its future dividends. Ideal for steady dividend payers.
Value = D / (r − g)6. Owner Earnings (Buffett)
Warren Buffett's approach: discount ten years of true owner earnings. For durable quality companies.
Owner earnings = net income + D&A − maintenance capexExample: fair value step by step
A made-up company earns $4.00 per share, grows its earnings about 8% a year, pays a 2% dividend and trades at $50. Three of the methods above:
- Earnings multiple: $4.00 × a fair P/E of 15 = $60
- Peter Lynch: fair P/E ≈ 8 + 2 = 10, so $4.00 × 10 = $40
- Graham: $4.00 × (8.5 + 2 × 8) × 4.4 / 4.5 = about $96 (with a bond yield Y of 4.5%)
The three results range from $40 to $96. The middle value, $60, is above the price of $50: by these three methods the stock looks cheap. The wide range shows, though, how much the result depends on the method and the inputs. That is why it pays to combine several methods and check the inputs.
Related models and ratios
The discount rate r that DCF and DDM need above is itself estimated: the Fama-French three-factor model derives expected return from the market, size and value factors. For growth stocks, the PEG ratio puts the P/E in the context of growth.
Frequently asked questions
How do you calculate the fair value of a stock?
In three steps: pick a method that fits the company (for example DCF for predictable cash flows, P/E or Peter Lynch for stable or growing earnings, the dividend model for dividend payers), take the inputs such as earnings per share, growth and interest rate from the latest annual report, then compute the value and compare it with the share price. Several methods and their range are more robust than a single number.
What is the formula for fair value?
There is no single formula. The simplest is fair value = earnings per share × a fair P/E, for example $4.00 × 15 = $60. The more thorough DCF formula adds up the discounted future free cash flows: value = Σ FCFₜ / (1+r)ᵗ + terminal value.
What is a fair value estimate?
A model's estimate of what a share is really worth, based on the company's earnings, cash flows, growth and risk. It is an estimate, not a certainty: other methods and assumptions give other values. That is why the range and the quality of the data matter as much as the number itself.
Is fair value the same as market value?
No. Fair value is the intrinsic worth justified by the fundamentals; market value is the current share price. Over time they converge, but short term they can differ a lot, and that gap is exactly what you look for.
Which method is best?
No single one. Each has strengths depending on the company. That is why Fair Value Calculator runs 26 models and weights them by evidence, instead of relying on one formula.
What is the fastest way to calculate fair value?
Automatically: enter a stock into Fair Value Calculator and all 26 models run on audited fundamentals, giving you a fair value plus quality and evidence right away, free.