The intrinsic value (also named Fair Value is defined in the book The Intelligent Investor by Benjamin Graham as "the underlying value of a company or stock based on fundamental analysis that can enhance profitability or discounted future cash flow analysis, with the aim of finding out what the company is worth." In simpler terms, intrinsic value is what a company is worth, taking into account all of its intrinsic factors such as assets, liabilities, and future prospects.
The intrinsic value is different from the market price and does not take into account a company's current stock price or recent volatility in prices. It is a more reliable way to determine the value of a company and can help investors make informed decisions about investments.
The role of the investor is to estimate the intrinsic value in order to determine whether or not it is undervalued. If the intrinsic value is greater than the market price, the stock might be a good buy. If the market price is greater than the intrinsic value, then it might be a bad buy.
In the long term, investing in companies with higher intrinsic values may lead to improved returns as the companies realize their fair value. In short, the intrinsic value helps investors decide when to buy, hold, or sell stocks.
There are different methods to calculate the intrinsic value of a company or stock.
The traditional approach is to use Discounted Cash Flow (DCF) or residual income valuation. This method can help predict the value of a company's future cash flows. This method is commonly used for stocks and can help investors determine whether a stock is undervalued.
Another method to calculate intrinsic value focuses on a company's balance sheet. This method entails analyzing the company's assets, liabilities, and financial performance to determine its fundamental value.
Finally, dividend discount models are used by investors to estimate the value of a stock based on the dividend it pays out to investors. Dividend-discount models attempt to calculate the present value of future dividends in order to assess a stock's intrinsic value.
Many investors overlook the importance of intrinsic value and are easily influenced by a company's market price. This is why properly determining the intrinsic value of a company or stock is important.
The market price differs from the intrinsic value because it reflects the collective mood of all the people involved in the market, which can be influenced by factors such as news, speculation, and market sentiment.
The intrinsic value of a company or stock is more reliable and stable method compared to the market price. It is determined through fundamental analysis and involves looking at the company's balance sheet, income statement, and operational performance.
On the other hand, the market price of a stock may not necessarily reflect the company's true value, which can create opportunities for investors to buy a stock at an undervalued price. It is important to understand the difference between the market price and intrinsic value in order to make informed investment decisions.