INTRINSIC VALUE

Saturday Brain Storming Thought (143) 11/12/2021

COMPILED BY ER. AVINASH KULKARNI

INTRINSIC VALUE

Intrinsic value is a measure of what an asset is worth

This measure is arrived at by means of an objective calculation or complex financial model, rather than using the currently trading market price of that asset

Intrinsic value is a philosophical investment concept that helps investors find the perceived value of an asset and determine whether the asset is being offered at a value over or under the market value of the asset

Intrinsic value is the sum of all of the company’s assets minus it’s liabilities

The intrinsic value of stock

Successful long term investors consider the intrinsic value of a stock before buying and when deciding to sell

Intrinsic stock value as a fundamental value of the stock

Analyze the stock to determine its price based on predicted future income and then subtract the current stock price

The formula for calculating the intrinsic value of stock

V = [EPS X (8.5 + 2g) X 4.4] / Y

V = Intrinsic value

Y = the current yield of AAA corporate bonds

Constant 4.4 = the average yield of high-grade corporate bonds in the early 1960 decade

g = being an estimate of the long term growth

Constant 8.5 = representing an expected price to earnings ratio, P/E ratio, for a company that is not growing

EPS = preceding 12 months earning per share

AAA Corporate bonds

AAA is the highest possible rating that may be assigned to an issuers bonds by any of the major credit rating agencies

AAA-rated bonds have a high degree of creditworthiness because their issues are easily able to meet financial commitments and have the lowest risk of default

Relative Graham Value (RGV)

Intrinsic value divided by current price is referred to as the Relatives Graham value of RGV

An RGV of more than 1 indicates a buy if less than 1 indicates that one should ignore the stock or sell if it is already in one’s portfolio

A company with strong products, low debt, and substantial hard assets can be a value stock that an investor will hold for years

When the margin of safety evaporates with bad management, poor product performance, or other reasons the intrinsic stock value will sink to that of the current stock price

Key points for Intrinsic value

1) to have worth itself, independent of relations to other things

2) seems something as being truly important for its own sake ie respect of essence

3) the worth of any given thing, person, animal etc that comes through the mere existence of that entity

4) possessing worth independent of that interpreted or projected by an individual (worth in and of itself)

5) the worth an object/being has that is inherent to its being (not what it can be used for)

6) the idea that something has inherent worth simply because it exists

7) existence in and of itself independent of the existence of others

8) giving creatures in nature more worth based on what type of creature they are

9) how much something is worth to itself

10) the importance and worth of an item, animal, person, plant etc independent of just what it can provide instrumentally

Risk adjusting the intrinsic value

1) Discount rate

Using a discount rate that includes a risk premium in it to adequately discount the cash flows

2) Certainty factor

Using a factor on a scale of 0-100% certainty of the cash flows in the forecast materializing (used by Warren Buffett)

Challenges with Intrinsic value

1) calculation is a very subjective exercise

2) so many assumptions required to be made

3) sensitive to changes in those assumptions

4) the assumption around the confidence/probability factor is entirely subjective

5) predicting the future is uncertain

Intrinsic value can be never negative

Currency, Bitcoins (or most of the cryptocurrencies) is also not backed by any gold or silver hence does not have any intrinsic value

Extrinsic Value

Extrinsic value is also the portion of the worth that has been assigned to an option by factors other than the underlying assets price

Extrinsic value is the opposite of intrinsic value

The intrinsic value of the gold coin

Also known as melt value ie the value of the precious metal in the coin

The intrinsic value of education

Education has its intrinsic value in terms of abstract concepts like intellect, wisdom, and knowledge

The intrinsic value of education is determined by the definition of education

The intrinsic value of Tata Motors

On 30/09/2021

Intrinsic value – Rs 37.77

Market Price – Rs 333.35

The intrinsic value of NPTC

On 30/09/2021

Intrinsic value – Rs 158.18

Market Price – Rs 141.85

The intrinsic value of BHEL

On 30/09/2021

Intrinsic value – Rs 60.88

Market Price – Rs 64.65

The intrinsic value of SBI

On 30/09/2021

Intrinsic value – Rs 604.95

Market Price – Rs 453.00

Advantages of intrinsic value calculation

1) can uncover undervalued or discounted investment opportunities

2) it shows the amount of profit in options contracts

3) determine the value of an asset

Disadvantages of intrinsic value

1) intrinsic value of options doesn’t show the full picture

2) it’s missing extrinsic value factors like time value

3) there is no 100% accurate method to calculate the intrinsic value

4) it relies on estimations of future cash flows and risk

Methods of determining the intrinsic value

1) Discounted Cash flow analysis

2) dividend discount model

3) asset-based valuation

4) analysis based on a financial metric

The market price is less than the Intrinsic value

If the intrinsic value of a stock is greater than the market value of stock, an intrinsic value investor will look as on opportunity and by the stock at its current market value in expectation of gain