Intrinsic Value

Looking investment management through Intrinsic Value

In general terms, the intrinsic value is understood as value which is justified by the facts, example: the assets, earnings, dividends, definite prospects, as distinct. So, before you earn your hard-earned money in stock, it is better for you to know the value you can expect to get in return. The value you assign to a stock, or we can say it is a stock’s intrinsic value, which is the  maximum amount that you are willing to pay for now for future benefits.

It make no sense to buy a stocks when its intrinsic value is smaller than current price. The future benefits you are expecting could come from dividends or the potential sales of the stock at a future price from now. Intrinsic value are more to a estimation than precise figure or calculation format and is more to a growth investment plan if you are asking.

Computing Intrinsic Value

Every individual has a different analysis skills thus assessing companies in a different point of view into a companies future prospect. Their acceptance of risk and tolerance might be differ as well, hence the intrinsic value is different from one individual to another. For most companies, the major component in computing intrinsic value comes from their future earnings. For that, you can start forecasting the future earning by looking at their growth rate based on their past performance. Apply the estimated growth rate to a future years, say a 5 years from now and apply a P/E multiple to the future earnings per share to estimate the value of those earnings in future and discount them to their present value. While it is only a simple approach, it does require a lot of assumptions like P/E multiple, growth rate, discount rate and etc. Its easy to say than done, but you have to start from something at the very least.

investment management-intrinsic value

When to buy stocks

Computing intrinsic value, we know that we should only buy a stock when the intrinsic value of the stock price is lower than market price. But “how much lower should the price be relative to the intrinsic value?” In this case, consider yourselves a safety margin. If you buy a stock at its intrinsic value, you will have no margin of safety. if everything goes as your assumption, you will have an annual return equivalent to the discount rate assumed, and vice versa. So always buy a stock with large margin of safety or an alternate way is to assumed a large discount rate.

Given that there are a lot of assumptions taken in place, you should always compute the intrinsic value based on different numbers on those assumptions and apply the value investing methodological for a better analysis. The proportion you invest should depend on its margin of safety and your confidence of your computation of the intrinsic value. You should only invest when the margin of safety is high.