Value-based Investment- The Intrinsic Value of a Stock


Last time we concluded by defining the IV of a stock. An Intrinsic Value is not always the same as the sticker price (but sometimes it could be). Rather, It’s the inherent value that this business deserves in today’s market.

Simply put, it’s very similar to the net-worth of an individual. You add up the sources of income and subtract the expenses. What you’re left with is that person’s net-worth. Same thing with businesses. What is the expected income from operation? What would be the value of all assets if they got liquidated? Patents, royalties, etc. Anything that the company owns and can convert into cash, minus whatever loans or liabilities it has in the market.

Next, divide that by the number of shares the business has (or intends to make) available in the market. For example, say the calculation we just made above resulted in ten million dollars. That is the net-worth of the business. The number of shares is one million. This gives rise to an IV of $10. This is what a single share of that business is intrinsically worth!

Armed with this knowledge, your decision-making process becomes a whole lot easier. You now have a baseline to come back to. Now, and only now, you go ahead and check the current sticker price of the business; what Mr. Market “feels” the price of one share of that business should be today! If Mr. Market was in a good mood and wanted to raise the price above $10 per share, then as an “Intelligent Investor”[1], you would hold back and keep the stock symbol on your wishlist. If the sticker price was less than ten, then the next step of investigation would kick in: Is it a business you would own for a 100 years, proudly? In other words, Is it a “wonderful”, growth, and money-making business?

That will be the subject of the next episode of this series. Stay tuned and be well…

To be continued…

 

The Wealth Maker

 

[1] Ben Graham has a book holding the same title. I’m not sure if he was the first to use this term though. The book is one of the best references on value-based investing.

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3 thoughts on “Value-based Investment- The Intrinsic Value of a Stock

  1. How do you fully calculate the intrinsic value of a company if some of those assets are not really hard. What if a company holds shares in another company? Even the intrinsic value of patents that a company holds can be subjective and time based. Do you have to determine the intrinsic value of all holdings? How deep do you go?

    Maybe I am over-complicating this.

    1. Thanks for your thoughtful comment!

      Yes, assets could be tangible (buildings, cash, furniture, equipment, etc) or intangible (patents, royalties, brand subjective value, etc). The IV serves as a baseline. We don’t buy or sell at the IV. The calculation should be as accurate as possible. Most of the information about public companies is available online. A great resource would be annual reports.

      Start with the tangibles, then move into the intangibles and figure out the corresponding financial value of each, to the best of your knowledge. However, set a time limit for such research. Finally come up with a value that you are satisfied with. The process takes practice. Your IV determination improves from one business to the next.

      All the best,

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