What is intrinsic value of stock and how it is calculated?

  • Asked By
  • Updated On:
    26-May-2021
  • Replies:
    2

Short Answer

Intrinsic value basically means real stock value and can be calculated using these three ways:

  • Discounted cash flow analysis
  • Analysis based on financial metric
  • Dividend Discount method

Detailed Answer

Introduction

There are various ways by which the worth of an investment can be determined. Value investors, on the other hand, favor a particular type of value measurement known as intrinsic value. Marketplaces, for example, show you what consumers are willing to pay right here for shares of the company or securities issued by a corporation.

Intrinsic value will provide you with a more in-depth and knowledgeable view of an investment's worth.

Intrinsic value:

The true value of stock can be said as Intrinsic value. Its valuation is done as per cash flows of an investment. The present value of anticipated future cash flows, discounted at the accurate discount rate, is the intrinsic value of a share, or any protection. All its products are concluded through fundamental analysis. It is the estimated current value of all projected future revenues at the required discount rate. As a consequence, technical analysis only assists in evaluating the direction and magnitude of stock price movement.

In general terms, it measures the actual worth of the asset. Rather than using the current selling price of that commodity in the market, this metric can be achieved by estimating a target or using a complicated financial framework. In order to obtain a decent profit margin, investors try to buy the stock beneath or at this price.

Calculation of Intrinsic Value:

Intrinsic value can be calculated in mainly three ways:

1. Discounted cash flow analysis (DCF Analysis)

This is one of the most beneficial and trustable ways to calculate intrinsic value. The operating income is used in discounted cash flow analysis to calculate the asset's present value or financial value. Using the firm's Weighted Average Cost of Capital, the analyst estimates the corporation's potential cash flow and discounts it to current value (WACC). It tells the investor whether the investment he is making right now will yield the expected return in the future. This is the formula which will help in calculating the DCF:

DCF = CF1/(1+r)1 + CF2/(1+r)2 + CFn/(1+r) n

Where

CF denotes the cash balance for a span of n years, and

R denoted the discount rate

It can also be said as current value. Usually, investors do this to when they buy any asset to predict its future value. The proposed expenditure would be a successful one if the project's expense is less than the estimated DCF. When businesses use DCF, they replace the discount rate with the WACC (Weighted Average Cost of Debt and Equity). This approach can be used to assess any asset, including options, shares, real estate, and other financial instruments.

2. Analysis based on Financial metric:

This is also one of the basic methods to calculate the Intrinsic value and is also quite easy and quick. It uses the method of P/E (Price to earnings) ratio to find the value of stock:

Intrinsic value = Earnings per share (EPS) x (1 + r) x P/E ratio

Where, r = the expected earnings growth rate

Using this formula, the asset buyers can determine the future price of the same which can help them in determining their choice in a better way.

3. Dividend Discount Method (DDM)

This model takes the dollar dividend pay-out ratio to shareholders into account. This model also takes into account the dividend's expected growth rate. A discount rate is used to minimise earnings to their current value. It basically helps in calculating the time value of money. It is essentially used in large capitalization companies to make better decisions.

Stock Intrinsic Price = DPS1 / (r - g)

in which:

DPS1 = Dividends anticipated one year from now.

r = The investment's discount rate or necessary rate of return.

g = The average dividend growth rate in due course.

Basically, an analyst predicts this i.e., a dividend is a distribution of a company's profits to its owners. If a business's profits are likely to increase, an analyst might predict that dividends distributed to investors will rise as well.

Conclusion:

Intrinsic value plays a major role in every asset and security. As it also helps in deciding whether the asset is overvalued or undervalued which helps in drawing the suture metrics. It also helps to understand if that particular asset is good to invest or not. Calculating the intrinsic value helps in sorting out the problems faced by the asset buyers regarding its value. The general concept is to purchase an asset for less than what it is valued, and calculating intrinsic value will assist you in doing so.

Tagged With: Intrinsic valuecalculationDiscounted cash flow analysisfinancial metricdividend discount
Categories: Stock Market
Ask Your Query for FREE, Get quick answers from our FINTRAKK community!
Discussion (1)

Intrinsic value is used mostly by investors looking to reap significant gains from their investments. However, keep in mind that intrinsic value might differ and might not be the only reliable tool to determine the value of the share.

Related FAQs
How to check dividend history in Zerodha?

The dividend history can be checked through the Zerodha console or Zerodha Kite app . For that you will have Go to the Profile section, and the tap on Portfolio in the Console menu. Then tap on the desired stock and then tap on View dividends .

For long-term investments, which channels are viable for significant returns given the current market scenario?

For significant returns, one can look forward towards stock funds, real estate investments, dividend stocks, target-date funds and so on. Each one of these investments does offer something better to investors based on their capital of investments made.

What are 7 important questions to ask before you buy a stocks?

Undertaking fundamental analysis and proper research is essential before investing in any particular stock. Apart from this, you should also consider asking seven key questions like 'What does the company do', 'How is it placed among its peers', 'How is the management of the company', etc before investing in it.

What are benefits of investing in blue-chip?

Blue-chip are stocks of reputed and financially sound companies. Investing in blue-chip stocks comes with numerous benefits. Let's see what are the advantages of putting money in blue-chip stocks.

Which is best 5paisa vs Zerodha stock broker?

You might have read about different stock brokers in India. Here I'll review two of the most popular discount brokers in India: 5Paisa v/s Zerodha Comparison.

IPOs seem the modern money multiplying investment, Should you invest?

Good quality IPOs are great options for investors when considering investing in an IPO. However, IPOs should not be taken as money multiplier instruments and invested in. Multiple IPOs have performed badly due to extremely high valuations and poor financials. Hence, it is important to evaluate the financials of the company before investing in them.

What are best stocks for college students to invest in India?

The best stocks for college students to invest in in India are those with strong fundamentals and high dividend yields, such as Reliance Ltd., ITC Ltd., and Infosys Ltd.

Why did some of the recent IPOs gave poor listing gains? Is the IPO craze over?

IPOs have been extremely popular lately as a result of increased retail participation, ongoing bull run, and massive listing gain opportunities. However, the Indian stock markets went through a minor correction which resulted in a muted performance of some IPOs. The market negativity coupled with the lofty valuations of some of the IPOs led to poor listing gains, but the craze might not be over.

Why did the Paytm IPO did not perform well after listing?

One97 Communications, the parent company of Paytm came up with the largest IPO in Indian history but failed to perform well. Firstly the IPO was too big for the retail investors to digest. Then the valuations were extremely high which led to the HNIs and Institutions avoiding the issue. All together the overhype in social media led to massive losses for the retail investors as the stock fell almost 40% in two trading sessions.

How to do Short Selling in Zerodha?

So, you wish to know how to do short selling in Zerodha or with any stock broker for that matter. In simple words, Short selling is When you go short, you sell the stock first and buy it later. The same has been explained in detail here.