Determining Stock Intrinsic Value

A stock’s intrinsic value is the perceived “real value” of a stock as calculated through the value of a company’s expected future cash flows and other factors. If the value is determined to be higher than what the stock is currently priced at, the stock is considered to be undervalued. There is no one intrinsic value for a stock at any given time as the approach to determining this value can vary by investor.

The use of a stock’s intrinsic value can distinguish value investors from growth investors. While growth investors rely heavily on earnings estimates to make their stock picks, value investors seek out stocks trading below their intrinsic value and hold those stocks until the market’s perception has adjusted properly (resulting in profit through appreciation of the stock price).

The key for value investors is in the margin of safety, which is the measure of the distance between the current market price and the intrinsic value. The wider the margin of safety, the more attractive the stock investment will be and the lower the perceived risk.

Value investors employ fundamental analysis to review both qualitative (business model, company management, etc.) and quantitative (financial statement analysis) aspects of a company in determining its intrinsic value and investment worthiness. The calculated value may not be the same as the market price as the stock may be currently under of overvalued.

The future performance of a company, though, (especially with regard to cash flows) is not guaranteed, making the calculation of intrinsic value simply an approximation. Even stocks that offer a very wide margin of safety are not worth considering if the company fundamentals are not sound, the management team is questionable, and the future of that industry is not promising. It is in the investor’s best interest to understand the all aspects of the business as thoroughly as possible and leverage multiple data points in arriving at an investment decision.

Check out our discounted cash flow calculator for an approach to arriving at valuation through the company’s free cash flow.

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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