What Is Intrinsic Value?

If you’re new to val­ue invest­ing, you’ll hear about “intrin­sic val­ue” a lot, because we only want to buy a stock if we think its price is low­er than its intrin­sic val­ue (eg we want to buy it at a dis­count).

But what does the term “intrin­sic val­ue” mean from an invest­ing per­spec­tive? And how do we cal­cu­late it?

Intrin­sic val­ue is a term used in finance to describe the inher­ent or true val­ue of an asset, such as a com­pa­ny’s stock or a bond. It is a key con­cept in fun­da­men­tal analy­sis, which is a method of eval­u­at­ing secu­ri­ties by ana­lyz­ing their under­ly­ing finan­cial and eco­nom­ic char­ac­ter­is­tics. The intrin­sic val­ue of an asset is con­sid­ered to be dis­tinct from its mar­ket price, which is deter­mined by sup­ply and demand forces in the mar­ket.

One way to think about intrin­sic val­ue is as the present val­ue of the future cash flows that an asset is expect­ed to gen­er­ate. For a com­pa­ny’s stock, this means con­sid­er­ing the com­pa­ny’s future prof­its, div­i­dends, and any oth­er sources of val­ue that the com­pa­ny may gen­er­ate. The intrin­sic val­ue of a bond, on the oth­er hand, is typ­i­cal­ly based on the present val­ue of the bond’s future inter­est pay­ments and prin­ci­pal repay­ment.

Deter­min­ing the intrin­sic val­ue of an asset is an impor­tant task for investors, as it can help them make informed deci­sions about whether to buy or sell the asset. If an asset is trad­ing at a price that is sig­nif­i­cant­ly low­er than its intrin­sic val­ue, it may be con­sid­ered under­val­ued and poten­tial­ly a good buy­ing oppor­tu­ni­ty. On the oth­er hand, if an asset is trad­ing at a price that is sig­nif­i­cant­ly high­er than its intrin­sic val­ue, it may be con­sid­ered over­val­ued and poten­tial­ly a good sell­ing oppor­tu­ni­ty.

There are sev­er­al meth­ods that can be used to esti­mate the intrin­sic val­ue of an asset, each with its own strengths and lim­i­ta­tions. Some of the most com­mon meth­ods include:

1. Dis­count­ed Cash Flow (DCF) Analy­sis: This method involves esti­mat­ing the future cash flows that an asset is expect­ed to gen­er­ate and then dis­count­ing those cash flows back to their present val­ue using a dis­count rate. The dis­count rate is a mea­sure of the time val­ue of mon­ey, which reflects the idea that a dol­lar received in the future is worth less than a dol­lar received today. The intrin­sic val­ue of the asset is then cal­cu­lat­ed as the sum of all the dis­count­ed cash flows.
2. Price-to-Earn­ings (P/E) Ratio: This method involves divid­ing a com­pa­ny’s stock price by its earn­ings per share (EPS). The result­ing ratio, known as the P/E ratio, is a mea­sure of the com­pa­ny’s val­u­a­tion rel­a­tive to its earn­ings. A low­er P/E ratio may indi­cate that a stock is under­val­ued, while a high­er P/E ratio may indi­cate that it is over­val­ued.
3. Div­i­dend Dis­count Mod­el (DDM): This method involves esti­mat­ing the future div­i­dends that a com­pa­ny’s stock is expect­ed to pay and then dis­count­ing those div­i­dends back to their present val­ue using a dis­count rate. The intrin­sic val­ue of the stock is then cal­cu­lat­ed as the sum of all the dis­count­ed div­i­dends.
4. Com­pa­ra­ble Com­pa­nies Analy­sis: This method involves com­par­ing the finan­cial and oper­at­ing met­rics of a com­pa­ny to those of sim­i­lar com­pa­nies in the same indus­try. By exam­in­ing met­rics such as P/E ratios, price-to-book ratios, and return on equi­ty, investors can gain insight into the rel­a­tive val­u­a­tion of a com­pa­ny.

It is impor­tant to note that deter­min­ing the intrin­sic val­ue of an asset is not an exact sci­ence, and dif­fer­ent meth­ods may yield dif­fer­ent results. Addi­tion­al­ly, the intrin­sic val­ue of an asset can change over time as the under­ly­ing eco­nom­ic and finan­cial fac­tors that dri­ve it change. As a result, it is impor­tant for investors to reg­u­lar­ly reassess the intrin­sic val­ue of their assets and make adjust­ments to their port­fo­lios as need­ed.

In con­clu­sion, intrin­sic val­ue is a con­cept that is cen­tral to fun­da­men­tal analy­sis, and it refers to the inher­ent or true val­ue of an asset. Deter­min­ing the intrin­sic val­ue of an asset can help investors make informed deci­sions about whether to buy or sell the asset, and there are sev­er­al meth­ods that can be used to cal­cu­late it.

Because deter­min­ing intrin­sic val­ue is such a dark art, in the QAV sys­tem we take a “heat map” approach to deter­min­ing whether or not a stock is under­val­ued. We look at sev­er­al intrin­sic val­ue cal­cu­la­tions and com­bine them with a bunch of oth­er met­rics, giv­ing each a score, and then buy­ing the stocks with the high­est total score (aka the QAV Score).