Summary: In finance, intrinsic value refers to the actual value of a company or stock determined through fundamental analysis without reference to its market value. It is also frequently called fundamental value. It is ordinarily calculated by summing the future income generated by the asset, and discounting it to the present value.
Intrinsic value is usually considered to be the true value of a financial asset. That true value should include both the things that are tangible and intangible about the asset. The intrinsic value is difficult to know for sure, so most of the time when people are discussing intrinsic values what they are discussing is the perception of that true value.
Market Value v. Intrinsic Value
Market value is the value that an asset is being sold for, which may not be the true value of the asset. Just because an asset is selling for a particular price doesn’t mean that the asset is worth what it is being sold for, as sometimes markets overvalue what is being sold, and other times they undervalue them. Intrinsic value can be determined through fundamental analysis to arrive at a value without relying on the market price.
Valuing Stock Options
One method used to estimate intrinsic value of call options it to subtract the strike price from the stock price, and then multiplying that result by the number of options that the holder is entitled to. This can be represented by the following formula:
Intrinsic Value = (Stock Price – Strike Price) x Number of Options
Valuing the intrinsic value of put options is very similar, but the stock price and strike place trade places in the above formula, so you would subtract the stock price from the strike price instead. Using this method can help find investors quality returns through stock options.
Valuing Stocks and Other Investments
Determining the intrinsic value of other types of investments, such as stocks by themselves or other property, is more difficult. Multiple methods can be used and investors don’t all agree on which way is best but each method has merits.
Discounted Cash Flow Method: By determining the future cash flows of an investment, and applying an expected rate of return, then summing the present value with all future value equals an intrinsic value.
Asset Based Valuation: Probably the most straightforward method, if the value of all assets can be determined and all liabilities are known, then the difference between the two may be the intrinsic value.
Financial Metric Analysis: Generally used with other factors, analyzing a financial metric such as price-to-earnings is a less scientific way of arriving at an intrinsic value.
After finding the intrinsic value of an investment, then comparing it with the market price, allows an investor to determine if the investment is over, or undervalued. Based on that information then true bargains in the market begin to appear.