What Is the Intrinsic Value Formula?
An intrinsic value formula is any mathematical computation that takes various business statistics attributed to a company, factors in underlying economic conditions, and comes out with a numerical value for the stock issued by that company. Comparing this value to the current stock price of the company ideally shows whether the company is overvalued or underrated. While many investors have their own specific intrinsic value formula, there are several formulas that have been developed by financial experts that allow investors to simply plug in the pertinent statistics and then arrive at the intrinsic value. Some of the factors that affect intrinsic value are the company's earnings per share and expected growth rate, reliability of growth projections, and available risk-free returns.
Investors do everything that they can to pick out stocks that are headed for a spike in price. This way, they can cash in on their equity at the improved prices and make a significant profit. The difficulty involved with this process is determining which stocks are undervalued. One way to do this is to find the intrinsic value of a stock, which is what it is actually worth regardless of the market price. As a result, developing a reliable intrinsic value formula is crucial to an investor's stock-picking success.
While there are many different choices available, there is no one surefire intrinsic value formula that exists. Many can be found that have been developed by top investment professionals, allowing investors to plug in the numbers, do a little math, and come out with some approximation of intrinsic value. Some investors come up with their own formulas or at least tweak the existing ones to fit their needs and expectations.
Although there is no definitive intrinsic value formula, many share similar characteristics. For example, a company's earnings per share is an excellent indicator of actual value and is used in most formulas. In addition, since stocks are likely to be held for a long period of time, investors also want to know the rate at which those earnings are projected to grow in the years to come and how reliable those projected earnings are. One major underlying factor usually included in formulas is the risk-free rate, which is the amount of return on investment that can be gained from investments with virtually no risk, like Treasury bonds.
Whatever intrinsic value formula is used, it should yield a number that is roughly the equivalent of the trading price of the stock in question. If the intrinsic value is significantly higher than the current stock price, the investor should consider buying. Should the stock price be much higher than the intrinsic value, a sell signal is sent to the investor.
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