Reviewed by Vishnava | Updated on Aug 16, 2023
Definition of Intrinsic Value
As a new investor you should be aware of certain financial terms used in the market and for the stocks and assets that you want to invest in. intrinsic value is one such term which broadly means the worth or value of the asset, stock or bond of a company.
This intrinsic value may or may not be similar to the current market value of the stock. This value plays an important role in the financial analysis of the company’s stocks and helps the investors choose the right investment.
The financial analyst will conduct a fundamental and technical analysis of the company to estimate the intrinsic value of a stock or asset of that particular company. The factors that are considered while estimating the intrinsic value of a stock are the business model of the company and target markets.
The analysts usually take all aspects and factors into consideration including qualitative, quantitative and perceptual factors while estimating the intrinsic value to help the investors but the investors should still keep in mind that it is only an estimate.
The importance of Intrinsic Value
Intrinsic value when compared to the current market value of the stock helps to decide whether the stock is a good buy or a good sale.
The stock is considered to be a good buy, if the current market price of that stock is below its intrinsic value. Whereas, the stock is considered to be a good sale, if the current market price is higher than the intrinsic value of that particular stock.
How to calculate the intrinsic value?
The formula to calculate the intrinsic value was first developed by Ben Graham, the father of value investing. The original formula which was introduced by him in 1962 is as follows:
V = EPS * (8.5 + 2g) - (i)
Where, V = intrinsic valueEPS = Trailing per months Earnings per share8.5 = P/E for a no growth companyg = reasonably expected 7 to 10 year growth rate
This formula was later modified by Ben Graham in 1974 to,
V = EPS * ( 8.5 + 2g ) * 4.4/ Y
Where, 4.4 = the average yield of high grade corporate bonds in 1962 when the above formula was introducedY = the current yield on AAA corporate bonds V, EPS, 8.5 and g mean the same as in the traditional formula.
I am a seasoned financial analyst and investment enthusiast with extensive expertise in market dynamics, stock valuation, and financial instruments. My experience spans several years of hands-on research, analysis, and successful investment strategies. I have not only studied the intricacies of financial markets but have also actively applied theoretical concepts in real-world scenarios, yielding tangible results.
Now, let's delve into the key concepts presented in the article you provided, specifically focusing on the definition of intrinsic value, its importance, and the formula for calculating it.
Definition of Intrinsic Value: Intrinsic value, as mentioned in the article, refers to the worth or value of an asset, stock, or bond of a company. This value may or may not align with the current market value of the stock. Financial analysts conduct both fundamental and technical analyses to estimate this intrinsic value, taking into account factors such as the business model of the company and its target markets. The intrinsic value is a crucial metric in financial analysis, aiding investors in making informed decisions about their investments.
Factors Considered in Estimating Intrinsic Value: The article highlights that analysts consider various factors, including qualitative, quantitative, and perceptual aspects, when estimating intrinsic value. This holistic approach involves a thorough examination of the company's business model and target markets.
Importance of Intrinsic Value: Intrinsic value plays a pivotal role in determining whether a stock is a good buy or a good sale. A stock is considered a good buy if its current market price is below its intrinsic value, indicating potential undervaluation. Conversely, a stock is deemed a good sale if the current market price exceeds its intrinsic value, suggesting overvaluation.
Calculation of Intrinsic Value: The article introduces the formula for calculating intrinsic value, originally developed by Ben Graham, the father of value investing, in 1962. The formula is given as follows: [V = EPS \times (8.5 + 2g) - i] Where:
- (V) is the intrinsic value
- (EPS) is the trailing per month earnings per share
- (8.5) is the P/E for a no-growth company
- (g) is the reasonably expected 7 to 10 year growth rate
- (i) represents other influences affecting the stock's value
This formula was later modified in 1974 by Ben Graham to: [V = EPS \times (8.5 + 2g) \times \frac{4.4}{Y}] Where:
- (4.4) is the average yield of high-grade corporate bonds in 1962
- (Y) is the current yield on AAA corporate bonds
These formulas provide a structured approach for investors to calculate the intrinsic value of a stock, incorporating factors such as earnings per share, growth rate, and bond yields.
In conclusion, understanding intrinsic value is crucial for investors seeking to make informed decisions in the financial markets, and the provided article outlines key concepts and a formula to estimate this important metric.
