If the price of a company’s stock went up, it’s more expensive, right? Well, not exactly. Stocks are not something static. Stocks represent part-ownership of an actual and ever-changing company.
Because the underlying company changes, its value may go up or down. If a company’s share price rises slower than its intrinsic value, the stock may have actually gotten cheaper even after the price increase.
What determines intrinsic value?
Most investors agree that a company’s intrinsic value is determined by the company’s cash on hand and the future free cash flows that it can generate. This cash can be used to grow the company or returned to shareholders through buybacks or dividends.
Investors often use historical price-to-earnings and price-to-free cash flow ratios as a proxy to gauge how cheap or expensive a company is.
Facebook is an example of a stock whose price has risen, but that has