Intrinsic value is the true worth of a share, measured by metrics such as earnings per share and future return, and taking into account a margin of safety. Investors use this to identify bargains in the market and determine if a stock is undervalued or overvalued.
The intrinsic value of shares is the measure of how much certain shares are actually worth rather than what their market price may be. This is an important concept for investors as it can allow them to identify bargains in the market and take advantage of them accordingly. In truth, the intrinsic value of stocks can be measured in many different ways, often depending on the individual investor’s preferred strategy. Most of the methods involve metrics such as earnings per share and also take expected future return into account, while also including the concept of margin of safety, which refers to the amount of slack an investor needs between intrinsic value and the market price before buying the stock. .
In many cases, the market price of a share can be misleading about the true value of the share. It may give a good read on the current state of the underlying company or business, but may not take into account its potential in the future. For that reason, investors try to come up with ways to determine the intrinsic value of shares, which gives an idea of how much they are really worth.
A simple way to determine the intrinsic value of stocks is to use the company’s earnings per share and measure it with a discount rate. The discount rate would be the percentage return on a safe investment like a government bond. For example, a stock earns $3 US dollars (USD) per share and is measured at a government bond discount rate yielding 5 percent. By dividing 0.05 by $3 USD, an intrinsic value of $60 USD per share is reached.
This is the simplest method of calculating the intrinsic value of stocks, and it produces a number that can be compared to the current price to determine if the stock is undervalued or overvalued. For example, if that stock in the example above had a current price of $45 per share, then it would represent a bargain. Using expected earnings per share for future years can give the investor an idea of the stock’s potential.
Since no method of calculating the intrinsic value of stocks is completely accurate all the time due to intangible factors, investors often stick to a margin of safety when using intrinsic value. This represents the percentage difference between the intrinsic value and the market price that the investor prefers before proceeding with their calculations. For example, an investor who prefers a 50 percent margin of safety targets a stock that he or she determines has an intrinsic value of $50 per share. Fifty percent of $50 USD is $25 USD, which means that the investor prefers the market price of the share to be $25 USD per share or less before buying.
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