Definition of Intrinsic Value
As a new investor you should be aware of certain financial terms used in the market and for the stocks and assets that you want to invest in. intrinsic value is one such term which broadly means the worth or value of the asset, stock or bond of a company.
This intrinsic value may or may not be similar to the current market value of the stock. This value plays an important role in the financial analysis of the company’s stocks and helps the investors choose the right investment.
The financial analyst will conduct a fundamental and technical analysis of the company to estimate the intrinsic value of a stock or asset of that particular company. The factors that are considered while estimating the intrinsic value of a stock are the business model of the company and target markets.
The analysts usually take all aspects and factors into consideration including qualitative, quantitative and perceptual factors while estimating the intrinsic value to help the investors but the investors should still keep in mind that it is only an estimate.
The importance of Intrinsic Value
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.
The stock is considered to be a good buy, if the current market price of that stock is below its intrinsic value. Whereas, the stock is considered to be a good sale, if the current market price is higher than the intrinsic value of that particular stock.
How to calculate the intrinsic value?
The formula to calculate the intrinsic value was first developed by Ben Graham, the father of value investing. The original formula which was introduced by him in 1962 is as follows:
V = EPS * (8.5 + 2g) - (i)
Where, V = intrinsic value EPS = Trailing per months Earnings per share 8.5 = P/E for a no growth company g = reasonably expected 7 to 10 year growth rate
This formula was later modified by Ben Graham in 1974 to,
V = EPS * ( 8.5 + 2g ) * 4.4/ Y
Where, 4.4 = the average yield of high grade corporate bonds in 1962 when the above formula was introduced Y = the current yield on AAA corporate bonds V, EPS, 8.5 and g mean the same as in the traditional formula.
