Price Prediction vs. Value Determination

You may be asking yourself what this whole idea of "determining value" is really about—and why it matters at all. Let's simplify it: there are only two fundamental ways people try to make money in the market.

Two approaches to profit

1) Price prediction

You buy something today because you believe someone else will pay more for it in the future. You're trying to anticipate how the market will behave—what other people will think, feel, and ultimately pay. Your success depends entirely on being right about future prices.

2) Value determination

You buy something today because you believe it is worth more than the price you're paying right now. You're not relying on the crowd — you're relying on the business itself and its ability to generate cash over time. Your success depends on being right about what the asset is actually worth.

The three main ways people analyze stocks

Most investors—whether they realize it or not—fall into one of three camps: technical analysis, relative valuation, or intrinsic valuation. The first two are different ways of playing the price prediction game; the third is firmly in the value determination camp. Let's briefly walk through each.

Technical analysis (reading the market itself)

Technical analysis focuses entirely on price movements and patterns, rather than what a business does or how much money it makes. Technical analysts study:

• Charts of past prices
• Trading volume (how many shares are being bought and sold)
• Patterns and indicators

The idea is that all known information is already reflected in the stock price, and that human behavior tends to repeat — so if patterns repeat, price movements can be anticipated. In practice, this looks like:

• Drawing trendlines on charts
• Identifying patterns like "head and shoulders" or "support and resistance"
• Using indicators that signal when something might be overbought or oversold

At its core, technical analysis is asking: "Based on how this has traded before, where is the price likely to go next?"

It is purely a price prediction tool.

Relative valuation (pricing by comparison)

Relative valuation doesn't try to predict price patterns. Instead, it looks for “cheap” businesses relative to similar businesses.

The logic is straightforward: if the market is willing to pay a certain price for a company with a given level of earnings (think of earnings as the cash left after paying the costs to run the business), then it should be willing to pay a similar price for another company with similar earnings.

In practice, investors compare things like:

• Price to earnings (how much investors pay for each dollar of profit)
• Price to sales
• Other ratios that link price to business performance

But this is where it gets tricky. It's rare to find two companies that are truly alike. Businesses differ in growth, risk, margins, and how stable their cash flows are. Because of that, investors have to adjust and “normalize” these comparisons to make them usable.

Simple example: imagine two companies that each generate $10 of earnings. If one trades at $100 and the other at $70, the second might look “cheap.” The assumption is that the market will eventually price them more similarly. But what if the cheaper company is riskier or growing slower? That's where judgment comes in.

We'll go much deeper into how professionals handle these adjustments in a later lesson.

At its core, relative valuation is asking: “What is the market willing to pay for something like this?”

Intrinsic valuation (pricing based on what it produces)

Intrinsic valuation is the only approach that directly answers the question:

"What am I willing to pay for this business today?"

This is fundamentally different from the other methods. Technical analysis and relative valuation both try to answer:

"What will other people be willing to pay for this in the future?"

Intrinsic valuation ignores the crowd entirely. Instead, it focuses on the business itself.

To figure out what you'd be willing to pay, you take a completely different approach: you look at the fundamentals of the business and estimate how much cash it will generate over time.

As an owner, that cash ultimately belongs to you—whether it's paid out directly as dividends or returned through share buybacks. The goal is to estimate how much cash the business will produce after covering its expenses and reinvesting what it needs to keep growing.

This leftover cash is called free cash flow. Fancy name, simple idea.

From there, the process is straightforward in principle:

• Estimate how much free cash the business will generate in the future
• Recognize that future cash is uncertain
• Reduce (or “discount”) those future dollars to reflect that uncertainty

Think of it like this:

• $100 you might receive 10 years from now could be worth far less to you today—maybe $10—because so much can change
• $100 you'll receive tomorrow is much more certain, so it might be worth $99 to you today

That's it. That's the whole idea.

Professionals wrap this in complex models and terminology, but at its core, intrinsic valuation is simply about estimating future cash and adjusting it for uncertainty to arrive at a price that makes sense today.

There are more refined tools and techniques used in practice to improve each step of this process—but big picture, this is all we're doing. We'll break it down in detail in the lessons ahead.

Putting it all together

Where this is going

All three approaches are widely used, but there are some subtle, potentially dangerous pitfalls we'll highlight with the relative valuation methods. In the next three lessons, we'll go deeper into each one:

• What each investment strategy looks like in practice
• Why people use the strategy they do
• Where the investment strategy breaks down

We'll then cover why you might want to transition to intrinsic valuation, or at least use it as a sense check at a bare minimum.