What is Intrinsic Value of a Share/Stock and How to Calculate: Meaning and Formula

Why Should You Care About Intrinsic Value?

Here's the thing, if you can figure out a stock's intrinsic value, you can identify good bargains. When a stock trades below its intrinsic value, it's like finding a designer jacket on sale. Warren Buffett made billions using this exact strategy, buying great companies when they were undervalued and waiting for the market to catch up. On the flip side, if a stock's market price is way above its intrinsic value, you know it's overpriced and probably best to avoid it.

What Affects Intrinsic Value?

Several things determine what a stock is really worth. Obviously, how much profit the company makes matters a lot. A company earning ₹100 crore annually is worth more than one earning ₹10 crore. Future growth potential matters too. A startup with massive growth prospects might be worth more than a stable but slow-growing business. Management quality plays a big role. Good leaders make smart decisions that increase company value. The company's competitive advantages like brand strength, patents, or market dominance also add to intrinsic value. And don't forget the assets, property, equipment, cash reserves, all of these contribute to what the company's actually worth.

How to Calculate Intrinsic Value

There are many formulas to calculate the intrinsic value. The easiest to start is the P/E (price to earnings ratio) method. Look up the company's EPS (earnings per share)(you will find this in their financial reports) Check what the P/E ratio of other companies in the same industry is at Multiply the EPS by that P/E ratio Compare your answer to the current stock price If your calculated intrinsic value is higher than the market price, the stock might be worth buying. If it's lower, the stock could be overpriced. The other elaborate methods to calculate intrinsic value are, · DCF - Values a stock based on the cash it is expected to generate in the future. · DDM - Values a stock by adding up its future dividend payments. · Comparable Analysis - Values a stock by comparing it with similar companies. · Asset-Based Valuation - Values a company based on what it owns minus what it owes. · Earnings Power Value - Values a company using its current, stable earnings. · Residual Income Model - Values a company using book value plus extra profits earned.

Finding Value Stocks Using Intrinsic Value

Value stocks are stocks trading below their intrinsic value, they are on sale compared to what they are actually worth. When you find a solid company whose stock price has dropped due to temporary problems or market overreaction, but its fundamentals remain strong, you have found a value stock. A great example is Tata Motors during 2020-21. The stock was trading around ₹100-150 when the intrinsic value based on its assets and future potential was much higher. Investors who recognised this saw the stock climb to ₹600+ over the next couple of years.

Keep These Limitations in Mind

Let’s understand this, intrinsic value isn't a crystal ball. It's making informed guesses about the future and sometimes they can go wrong. A company might not grow as expected. Economic conditions change. New competitors emerge. Regulations shift. Different calculation methods can also give you different answers for the same stock. That's normal. Intrinsic value is more of a range than an exact number.