Definition: Fair market value (FMV) is the price agreed between a buyer and a seller for a specific asset. Both parties should be aware of the asset’s condition and willing to participate in the transaction with no force. Also, there should be no time pressure for the completion of the deal.
What Does Fair Market Value Mean?
What is the definition of fair market value? FMV is the expected price that a buyer and a seller agree to a transaction in the open market. The fair market value is calculated based on a firm’s growth rate, profit margins, and potential risk. However, as it is extremely challenging to precisely determine how much a security is really worth, value investors invest in stocks that they expect will match their fair value.
Let’s look at an example.
The stock price of a technology company currently trades at $45. The technology company has just completed a deal with a competitive company for the launch of an innovative technology product, which is expected to sell. The company’s management has decided on the product’s packaging and has brought in some tech specialists to run the product before the launch. The management made all these changes seeking to gain a competitive edge over its rivals.
Jerry is an investor in the technology company. Reading about all these innovative moves in the newspapers, he believes that the company’s future cash flows will be higher. Jerry even expects that the stock will trade at $60 or above.
Can Jerry calculate the stock’s fair market value?
The answer is no. Jerry can only assess the situation and based on his personal margin of safety, determine that the stock’s fair value is $60 or $45 or even less. The stock’s attractiveness varies by investor. If Jerry’s required margin of safety is 25%, the FMV for him is around $55.
Define Fair Market Value: FMV is a measure of how much a product is worth based on the price a buyer is willing to pay and the price a seller is willing to accept.