By Vishweshwar HS, www.showmytrade.com
Every asset needs to ascertain its inherent or true value to make the transition in daily life. It will be tough to compare two asset classes if the true value not identified. How to find true or inherent value? And the characteristics features of an asset class in pricing an asset.
Intrinsic value is the inherent or true value of an asset. It measures “what an asset is worth?” Intrinsic value is arrived with objective calculation and with various financial models.
Intrinsic value is not an opinion, certainly not current market price that quoting, and agreed by buyer or seller in the stock market.
Intrinsic value is a general term mostly used by financial analysts to estimate an asset’s intrinsic value through fundamental and technical analysis. Let’s learn more about how to measure the intrinsic value of different asset classes.
Intrinsic Value of Equity Shares
When it comes to calculating the intrinsic value of a company, there is no hard and fast rule. However, financial analysts build best valuation models based on qualitative, quantitative, and perceptional factors of a company.
The Financial analyst considers factors like the business model, economic moat, quality of management, and product space that the company is operating. Then analyst quantifies in financial terms.
They analyze the Company’s Balance sheet, Profit & Loss A/c, and various financial ratios to measure how well the business performs. Several assumptions are assumed while calculating the intrinsic value. The analyst compares whether the asset is overvalued or undervalued.
Some analysts and investors might place a higher weight on the quality of the management, while others might give more importance to earnings and revenue.
Discounted Cash Flow and Intrinsic Value
The discounted cash flow (DCF) model is one of the conventional methods used to find out the intrinsic value. In DCF model uses a company’s free cash flow (terminal value) and discounting after the time value of the money.
Market Risk and Intrinsic Value
Markets risk, also one the key element while calculating the intrinsic value of a company. Risk measured by beta (how much the stock price volatile or fluctuate). A beta of one considered neutral, higher than one, means a stock has an increased risk of volatility, and a beta of less than one says it has less risk. If a stock has a high beta, there should be greater return (cash flow from the operation).
Investors try to use qualitative, quantitative, and perception factors to measure the intrinsic value of a company, but they should note that the result is still only an estimate.
If any assumption made while calculating the intrinsic value, what if a new product launch for a company didn’t give the success as expected. The intrinsic value will be lower than previously estimated.
Intrinsic value is a core concept of value investors. They buy a stock if the current market price is less than intrinsic value. They sell a stock when the current market price is much higher than the intrinsic value.
Intrinsic Value of Option Contract
If an Option contract is in-the-money, i.e., the current market price (CMP) is less than the strike price. For example, CMP is Rs 300, and the strike price is 250. The difference Rs 50 is the intrinsic value. On the other hand, if an option is out-of-the-money, i.e., CMP is 240, and the strike price is Rs 240, it’s intrinsic value is zero.
Intrinsic Value of Gold
Gold’s is a precious metal and being a preferred medium of exchange. The gold is known for its rarity, can store easily, can divide into small quantities, easily carry, and it is hard to counterfeit. Gold is a preferred instrument of trade (barter trading system). It is also a good hedging asset against inflation. Even now, gold has more value compare with paper currency.
Gold has a relatively small intrinsic industrial value, because of its value, it usually traded high.
Intrinsic Value of Bonds
A bond valued by calculating the current value of a bond’s future cash flow of interest payments, or its known future cash flows, along with the bond’s maturity value; this is a bond’s intrinsic value.
Intrinsic Value of Bitcoin & Other cryptocurrencies
Bitcoin or other cryptocurrencies used as a medium of exchange. It has some store value, and more importantly, it can hedge against inflation as it is in limited supply. As paper currencies backed by nothing, it has zero intrinsic value.
Intrinsic value is the real value of an asset, not an opinion, and not the current price it is trading at in the markets. Analysts often use fundamental and technical analysis to account for qualitative, quantitative, and perceptional factors in their models. The investor needs to know the intrinsic value and adjust the risk factors while investing!
Kindly share your comments on the “What is the Intrinsic Value?” below. Any suggestion regarding this article will update in the next edition.
Thanks for reading.