What is Intrinsic Value and why should you care about it?
According to The Montley Fool, Intrinsic Value refers to an investor’s perception of the inherent value of an asset, such as a company, stock, option, or real estate. Knowing an investment’s intrinsic value is useful for value investors who have a goal of buying stocks and other investments at a discount to this amount. In other words, Intrinsic value is the perceived worth of an asset. There are many ways to quantitatively and qualitatively calculate the value of assets.
This article explores the Intrinsic Value of Stocks, Bonds, and Options, primarily focusing on the calculation methods for Stocks and Options.
Intrinsic Value of Stocks
The Intrinsic value of Stocks is an important concept of both growth and value investors, although growth investors might focus more on quantitatively reasons that will catalyze their investments — the story behind the stock.
In general, investors start valuation through the Discounted cash flow analysis or metric based valuations.
- Discounted cash flow analysis uses the time value of money along with an estimation of a company’s future cash flows. The sum of the present value of all future cash flows is the intrinsic value. There are several variables that go into this type of analysis.
With a couple assumptions related to future expected cash flow (demand, economic cycle, acts of god, politics, etc), an investor can systematically estimate and compare the value of investments should their assumptions holds true. Although, the future may be unpredictable, this tool is intended to enhance an investors choices.
There a many free excel tools for ideas on creating your own tool, perhaps in google spreadsheet.
Another option is using an online calculator such as the one on http://www.moneychimp.com/articles/valuation/dcf.htm
Lazy? The perceived fair value can be found on many websites including the following:
- https://www.gurufocus.com/stock/AAPL/dcf
- https://www.stock-analysis-on.net/NASDAQ/Company/Apple-Inc/DCF/DDM
- https://financialmodelingprep.com/discounted-cash-flow-model-levered/AAPL
- https://finbox.com/NASDAQGS:AAPL/models/dcf-growth-exit-5yr
- Financial metrics based valuations
Value investors can also use automated tools such as https://finviz.com/screener.ashx fundamental screener perform metric based company valuation.
I tend to look at the metrics below prioritizing in the following order:
- P/E, P/B, PEG;
- EPS or Sales Growth;
- Operating Margin, Net Profit Margin;
- Debt/Equity, Price/Free Cash Flow;
- Payout Ratio, Return on Investment.
A series of sector based valuation or comparison of similar business models could give insights on valuation decisions.
Intrinsic value of Bonds
Bond valuation is a way to determine the theoretical fair value (or par value) of a particular bond. It involves calculating the present value of a bond’s expected future coupon payments, or cash flow, and the bond’s value upon maturity, or face value. As a bond’s par value and interest payments are set, bond valuation helps investors figure out what rate of return would make a bond investment worth the cost. (https://www.fool.com/)
Intrinsic value of Options
The Intrinsic value of an options contract is simply the difference between the price of the underlying Stock Price and the associated contract Strike Price multiplied by the number of options.
- Premium = Time Value + Intrinsic Value
- Call = Spot – Strike
- Put = Strike – Spot
- Time Value is max at the start of the contract and zero at expiration
Conclusion
