Business, Legal & Accounting Glossary
Intrinsic value is what an investor believes a company’s true value is.
The actual value of a security, as opposed to its market or book value, is the intrinsic value of the security. Intrinsic value may differ from market value because of brand names, patents and other intangibles that are difficult for investors to quantify. There are various approaches but no standard formula for calculating the intrinsic value of an asset. The concept of intrinsic value is also used in options trading where intrinsic value measures the amount by which the option is in the money. A call option’s intrinsic value is calculated by subtracting the strike price of the call option from the market price of the underlying security. A put option’s intrinsic value is measured by subtracting the market price of the underlying security from the strike price of the put option.
Value investors compare a company’s intrinsic value to its market value to calculate a margin of safety.
Over the years, there have been many definitions of intrinsic value. John Burr Williams, author of The Theory of Investment Value, defined it as the present value of future cash flows. Benjamin Graham defined it as “that value which is justified by the facts”. Warren Buffett has tended to use Williams’s definition. John Maynard Keynes looked at intrinsic value as the prospective yield or return on investment.
A perhaps less scholarly answer is simply to say that intrinsic value is the fair, or true, value of a stock. The most common ways to estimate intrinsic values are by using discounted cash flow analysis or relying on a multiple such as the P/E ratio, though asset-based valuations are commonly used for commodity-producing firms or holding companies. Value investors believe that market prices trend along with a stock’s intrinsic value over time.
Value investors strive to purchase assets trading for less than their intrinsic value, which affords them a margin of safety. The bigger the discount to intrinsic value (or, put another way, the larger the margin of safety), the more attractive the purchase price.
Although my company’s stock price was depressed, I was buying more shares because I believed the market did not take into account our valuable brand and trademarks that suggested the company’s intrinsic value was much higher.
Early purchasers of Netscape stock were treated to a harsh lesson in the stock’s intrinsic value, as they watched it plummet drastically only a few short years later.
It had a lot of intrinsic value and I was glad because I thought it might have been worthless and not have any value.
Margin of safety
Fair value
Value investing
Fundamental analysis
Market capitalization
in the money
specie
option value
option premium
conglomerate discount
option price
mispriced
market bubble
overinflated
technical analysis
In order to get the intrinsic value of a company, you need to do a valuation of a business, not look at other businesses or do technical analysis. The method used to figure out how much a company is worth can be different depending on what kind of company is being looked at.
For instance, profits or cash flow capitalization might be used to value a business that works in a stable environment and generates recurrent free cash flow. However, if a company’s future free cash flows are subject to change as a result of major capital investment (or another factor), the discounted cash flow approach may be a more appropriate tool for determining the company’s intrinsic value.
The critical point to remember is that a business’s intrinsic value can (and frequently does) differ significantly from its price. Intrinsic value is determined using several key fundamental tenets, including the following:
When a price is decided, it is frequently significantly different from the intrinsic value of a target, as its tenets are rarely in place. The parties may have radically different goals, access to knowledge, and negotiation abilities. In most cases, the buyer has specific acquisition objectives that may motivate payment of a premium over intrinsic value because the buyer believes the synergies obtained will improve the combined entity’s performance. Additionally, the buyer or seller may be navigating the deal emotionally. For instance, a seller who has established a 20-year business on his or her name may assume that the price is significantly greater than the business’s inherent value as assessed by a proper appraisal.
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This glossary post was last updated: 20th January, 2022 | 0 Views.