To start with, first of all, you should know what a stock is. A stock is a share of a company’s capital. You become a part-owner of the company if you own one. As far as you or the analysts are concerned, the intrinsic value is its fair worth.
Intrinsic Value Meaning
“The intrinsic value of a stock is more like its fair price that estimates a stock’s value without regard for the stock market’s valuation.”
When purchasing anything, whether it’s vegetables or consumer durables, you want to pay a reasonable price for it, not less or more. You might even try to buy it for a lesser price than its fair market worth. Stocks are the same way.
“The intrinsic value of a stock helps you understand whether it is overvalued or undervalued in someone’s opinion”.
How to Calculate the Value of a Share?
There are several methods for determining a stock’s intrinsic value. Here, we’ll talk about two ways:
- Dividend Discount Model
The dividend discount model estimates a stock’s price based on the sum of its future dividend payments. To put it another way, it takes the sum of all future dividends expected to be paid by a corporation and discounts them to arrive at their current worth.
The stock is undervalued if the DDM price is higher than the current value, and it is overvalued if the DDM price is lower.
Dividend discount models are classified as follows based on their level of complexity:
- Single period Model
- Multi-period Model
- Zero Growth Model
- Constant Growth Model
- Two-Stage Growth Model
- H Model
- Discounted Cash Flow analysis
In technical terms, a stock’s intrinsic value is the present value of all free cash flows (FCF) discounted at the weighted average cost of capital (WACC).
The following is the formula for calculating the intrinsic value using the DCF method:
Discounted cash flow = CF1/ (1+r)1 + CF2/ (1+r) 2 + CFn/ (1+r)n + terminal value of the business
CF = the cash flow of the nth year
r= the rate of discount
Why Intrinsic Value Is Important?
If the current market price of a stock is less than its intrinsic value, it is considered a good buy. If the current market price of a stock is more than its intrinsic worth, it is called a good sell.
“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.”
Intrinsic Value Analysis
Fundamental analysis should be done to assess whether a stock is undervalued, overvalued, or trading at fair market value.
The intrinsic value of a stock can be calculated by scrutinizing all available information about a corporation’s future expected growth, sales numbers, cost of operations, and industry structure.
To summarize, intrinsic value is an important factor to consider when evaluating a stock for investment purposes.
There are numerous ways for calculating a reasonable amount, and an investor should choose the one that is most suited to the sector and characteristics of the company under consideration.