What's Medibank really worth?

Anyone who answers with a precise number is wrong

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

On US talk show Charlie Rose last week, financial journalist Felix Salmon made a good point about market volatility:

"It is impossible to know the value of a company like Apple or Goldman Sachs to within a half a percent either way. But that's what you wind up doing when you look at the stock price. You say, 'Oh it went up a percent! Or down a percent!' That is pure noise in the distribution of roughly, more or less, where we think [the price] should be."

How true. And this is something that private companies handle better than public companies.

When a private company wants to know how much it is worth, management hires an investment bank, or a valuation consultant, which provides an opinion.

Analysts look at the company's financial statements, do some wizardry in Excel, and come up with a reasonable estimate for what the company is worth.

But when an investment bank presents a private business owner with a fairness opinion, you will almost never see this:

"We think your company is worth $18.16 per share."

Instead, you'll almost always see something like this:

"We think your company is worth between $17 and $19 per share."

Precisely, exactly wrong

Valuations are given in a range, not an exact value.

There's a good reason for this.

All valuation estimates are just that — estimates. They're an attempt to predict a future that, in reality, cannot be known.

To value a company, I have to know what future interest rates will be, for example. But I don't. And I can't.

I can, however, come up with a reasonable range of possibilities.

I can't look at you with a straight face and say 10-year US Treasuries (often used as a proxy for a 'risk free' return) will yield 4.21% in January 2017. But if I said there's a good chance 10-year Treasuries will yield somewhere between 3% and 5% in January 2017, that's more realistic. (The range could still be off, but it has a better chance of being more or less right.)

Same goes with earnings growth, capital spending, cost of goods sold, and dozens of other variables. The future is thought of in a range of probabilistic outcomes, so current valuations are presented in a range, too.

But the stock market doesn't.

The hares are off and running

As I write, your Medibank shares are trading for $2.20 a share. There's no range of possibilities — not "between $1.80 and $2.30 a share." The exact price, right now, is $2.20. That's what the market estimates Medibank's future cash flows are worth, discounted back to today – and probably topped with more than a little IPO hype.

But not even the market, which aggregates millions of opinions into a single price, can know exactly what the future holds. We can only make reasonable estimates about a range of outcomes.

The reality is that, even if Medibank (just to use an example) is priced at $2.20 a share, there's a range of prices that would be reasonable to pay.

It might be reasonable to pay $1.80 a share, or $2.30. Either probably makes sense given the range of potential future outcomes.

Thinking of values this way should change how you react to short-term volatility.

Morgan Housel is a Motley Fool columnist. You can follow The Motley Fool on Twitter @TheMotleyFoolAu. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on ⏸️ Investing

Close up of baby looking puzzled
Retail Shares

What has happened to the Baby Bunting (ASX:BBN) share price this year?

It's been a volatile year so far for the Aussie nursery retailer. We take a closer look

Read more »

woman holds sign saying 'we need change' at climate change protest
ETFs

3 ASX ETFs that invest in companies fighting climate change

If you want to shift some of your investments into more ethical companies, exchange-traded funds can offer a good option

Read more »

a jewellery store attendant stands at a cabinet displaying opulent necklaces and earrings featuring diamonds and precious stones.
⏸️ Investing

The Michael Hill (ASX: MHJ) share price poised for growth

Investors will be keeping an eye on the Michael Hill International Limited (ASX: MHJ) share price today. The keen interest…

Read more »

ASX shares buy unstoppable asx share price represented by man in superman cape pointing skyward
⏸️ Investing

The Atomos (ASX:AMS) share price is up 15% in a week

The Atomos (ASX: AMS) share price has surged 15% this week. Let's look at what's ahead as the company build…

Read more »

Two people in suits arm wrestle on a black and white chess board.
Retail Shares

How does the Temple & Webster (ASX:TPW) share price stack up against Nick Scali (ASX:NCK)?

How does the Temple & Webster (ASX: TPW) share price stack up against rival furniture retailer Nick Scali Limited (ASX:…

Read more »

A medical researcher works on a bichip, indicating share price movement in ASX tech companies
Healthcare Shares

The Aroa (ASX:ARX) share price has surged 60% since its IPO

The Aroa (ASX:ARX) share price has surged 60% since the Polynovo (ASX: PNV) competitor listed on the ASX in July.…

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »

⏸️ Investing

Why Fox (NASDAQ:FOX) might hurt News Corp (ASX:NWS) shareholders

News Corporation (ASX: NWS) might be facing some existential threats from its American cousins over the riots on 6 January

Read more »