What Are the Best Tips for Calculating Intrinsic Value?

Jim B.

Calculating intrinsic value is a process used by investors attempting to find the actual worth of a company issuing stock regardless of its stock price. Since there is no absolute formula for determining intrinsic value, investors should test various formulas by checking if the stocks the formulas judge as undervalued actually rise in price. There are numerous ways of calculating intrinsic value, most of which use some combination of earnings statistics, projected growth, and discount rates. In addition, investors might wish to include fundamental characteristics of the companies issuing the stock in their quest to determine intrinsic value.

Man climbing a rope
Man climbing a rope

Stock prices are determined solely by the supply and demand created when investors buy and sell stocks. As a result, some stocks may be overpriced compared to the actual worth of the companies that issue them, while others can be underrated. That is why many investors are concerned with intrinsic value, which ideally should determine how a stock performs over time. Calculating intrinsic value accurately requires trial and error, mathematical computations, and investing savvy.

Since finding an undervalued stock to buy is profitable for an investor, calculating intrinsic value should have that goal in mind. Determining intrinsic value, however, is by no means an exact science. Many investment experts have developed formulas, but investors should be prepared to test them before trusting them to make actual trades. Doing this requires filling in the numbers from targeted companies into these formulas, performing the math, and then seeing if the resulting intrinsic value accurately reflects the companies' fortunes over a period of time.

Many different ways of calculating intrinsic value are available to investors, but most have certain characteristics in common. Earnings per share, a measurement of how a company's income compares to its stock price, is an important metric for intrinsic value calculations. Projecting earnings growth over time is also important, since investors generally are looking to hold onto stocks for a long span. Finally, determining a discount rate to provide an accurate present value for future cash flows is also necessary.

While statistics are an important part of calculating intrinsic value, other intangible qualities surrounding a company can be important factors as well. These intangibles are often known as fundamentals, and they can be utilized to augment formulas. Key fundamentals include company management, market competition, and current events which may impact the company.

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