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.
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This glossary post was last updated: 6th August, 2021 | 2 Views.