Intrinsic value is a key concept in the value investing, since the decision to buy or sell a share will be based on the relationship between this value and the listed price. If the listing price is lower than the intrinsic value and offers a safety margin appropriate, a value investor will buy. Instead, if the price exceeds the intrinsic value, it will be time to sell. In this article we will see what the intrinsic value of an action is, the calculation methods, the problems that it entails and how we can solve them.
What is the intrinsic value of a stock?
The intrinsic value of a stock can be narrowly defined as the present value of the future cash flows of that stock. That is, the current value of the money that this action will make us earn in the future. To understand it better, I recommend you review my articles on the discounting cash flows from a theoretical point and practical example.
We must not confuse the intrinsic value of a share with its market value (see “capitalization bursátil”) Or your company value, which are two completely different concepts.
Methods for calculating intrinsic value
There are many different ways to calculate the intrinsic value of a stock. The most used are the following:
- Cash flow discount
- Methods based on equity value
- Relative valuation
- Methods based on real options
The most accurate method in theory is the discount of cash flows, although for a specific case we must use the most convenient method.
Inherent Intrinsic Value Problems
The main problem with intrinsic value is that, since there is no single method for its valuation, it can give disparate results depending on the method we use. Moreover, even using the same valuation method, many analysts obtain very different values. This is because different analysts may have different opinions about the strength of a company, its competitive advantages, or its potential for future growth.
My recommendation when calculating the intrinsic value of a stock is not to look for a single figure, but what I recommend is to create a range of values using the valuation through scenario analysis. Once the different scenarios with their respective valuations have been calculated, we give each scenario a probability and calculate the weighted average of the different scenarios, obtaining the intrinsic value of the share as a result.