Understanding how to find intrinsic value of stock is a crucial step in the stock valuation process. It helps investors determine the true value of a company’s shares based on its financial performance, future growth prospects, and market conditions. Intrinsic value is the present value of all future cash flows that a stock is expected to generate, discounted at an appropriate rate.
Several methods can be used to calculate intrinsic value, including discounted cash flow (DCF) analysis, dividend discount model (DDM), and price-to-earnings (P/E) and price-to-book (P/B) ratios. By finding the intrinsic value of a stock, investors can make informed investment decisions and minimize the risk of buying overvalued stocks.
Intrinsic Value – Definition
The intrinsic value of a stock is the true or inherent value of the stock based on the company’s fundamental data, financial performance, and future growth prospects. It is the present value of all future cash flows that a stock is expected to generate, discounted at an appropriate rate. In other words, the intrinsic value is what a stock is worth based on its actual underlying value, rather than its current market price or perceived value.
The intrinsic value calculation takes into account a company’s financial statements, earnings reports, cash flow statements, and other financial metrics to determine the stock’s fair value. It is an important concept in stock valuation as it helps investors make informed investment decisions and avoid buying overvalued or undervalued stocks.
Fundamental Analysis:
Fundamental analysis is a method used to evaluate the intrinsic value of a stock by analyzing the company’s financial statements and other relevant factors that can affect the company’s financial performance. Here are the steps to use fundamental analysis to find the intrinsic value of a stock:
- Analyze financial statements: Review the company’s financial statements, including the income statement, balance sheet, and cash flow statement. Analyze the financial statements to determine the company’s revenue, profitability, debt level, and cash flow.
- Evaluate the company’s competitive position: Analyze the company’s industry, market share, growth prospects, and competition. Determine the company’s competitive advantage and its ability to maintain or increase its market share.
- Assess the management team: Evaluate the quality and track record of the company’s management team. Look for a management team that has a proven track record of delivering results and making sound business decisions.
- Estimate future earnings and cash flows: Based on the analysis of the company’s financial statements, industry, and management team, estimate the future earnings and cash flows that the company is likely to generate.
- Determine the appropriate valuation multiple: Identify the appropriate valuation multiple for the company based on its industry and historical performance. Common valuation multiples include price-to-earnings (P/E) ratio, price-to-sales (P/S) ratio, and price-to-book (P/B) ratio.
- Calculate the intrinsic value: Using the estimated future earnings and cash flows and the appropriate valuation multiple, calculate the intrinsic value of the stock.
- Compare intrinsic value with market value: Compare the calculated intrinsic value with the current market price of the stock. If the intrinsic value is higher than the market price, the stock is undervalued and may be a good investment opportunity. Conversely, if the intrinsic value is lower than the market price, the stock is overvalued and may not be a good investment opportunity.
It is important to note that fundamental analysis is just one of many valuation models and should be used in conjunction with other models and metrics to get a comprehensive view of the stock’s intrinsic value. Additionally, the accuracy of the analysis depends on the quality of the financial statements and the assumptions made in the analysis.
Learn basics of Fundamental Analysis with the help of stock market courses on iTribe app. Install iTribe app now.
How To Find Intrinsic Value of Stock:
Let’s have a look at following 3 different methods to find the intrinsic value of the stock.
1. Discount Cash Flow (DCF):
Discounted Cash Flow (DCF) Analysis is a valuation method used to estimate the intrinsic value of an investment. It involves forecasting the future cash flows that an investment is expected to generate and discounting them back to their present value using an appropriate discount rate. The concept behind DCF analysis is that the value of an investment is equal to the sum of its future cash flows, discounted to their present value.
To use the Discounted Cash Flow (DCF) analysis to find the intrinsic value of a stock, follow these steps:
- Forecast future cash flows: Estimate the future cash flows that the company is expected to generate over a specific period of time. This can be done by analyzing the company’s historical financial statements, market trends, industry outlook, and other relevant factors.
- Determine the discount rate: Select an appropriate discount rate that reflects the company’s risk and the investor’s required rate of return. The discount rate should be consistent with the risk and return expectations of the investment.
- Calculate the present value of future cash flows: Using the forecasted cash flows and the discount rate, calculate the present value of each future cash flow by discounting it back to its present value.
- Add up the present values: Sum up the present values of all future cash flows to get the intrinsic value of the stock.
- Compare intrinsic value with market value: Compare the calculated intrinsic value with the current market price of the stock. If the intrinsic value is higher than the market price, the stock is undervalued and may be a good investment opportunity. Conversely, if the intrinsic value is lower than the market price, the stock is overvalued and may not be a good investment opportunity.
It is important to note that DCF analysis is just one of many valuation models and should be used in conjunction with other models and metrics to get a comprehensive view of the stock’s intrinsic value. Additionally, the accuracy of the DCF analysis depends on the quality of the cash flow forecasts, the appropriateness of the discount rate, and the assumptions made in the analysis.
2. Dividend Discount Model (DDM):
The Dividend Discount Model (DDM) is a method used to estimate the intrinsic value of a stock based on the present value of future dividend payments. It assumes that the intrinsic value of a stock is equal to the present value of all future dividend payments.
To use the DDM to find the intrinsic value of a stock, follow these steps:
- Estimate the future dividends: The first step is to estimate the future dividend payments that the company is expected to make. This requires an analysis of the company’s historical dividend payments, financial performance, growth prospects, and other relevant factors.
- Determine the discount rate: The next step is to determine the appropriate discount rate to use in the calculation. The discount rate should reflect the investor’s required rate of return and the risk associated with the investment. The discount rate is typically the company’s cost of capital or the investor’s required rate of return.
- Calculate the present value of future dividends: Using the estimated future dividend payments and the discount rate, calculate the present value of each future dividend payment. This involves discounting each dividend payment back to its present value using the chosen discount rate.
- Add up the present values: Finally, add up the present values of all future dividend payments to get the intrinsic value of the stock.
It is important to note that the DDM is just one of many valuation models and should be used in conjunction with other models and metrics to get a comprehensive view of the stock’s intrinsic value. Additionally, the DDM assumes that the company will continue to pay dividends in the future, which may not always be the case.
3. P/B Ratio:
The price-to-book (P/B) ratio is a financial ratio that compares a company’s market value to its book value. Book value is the value of a company’s assets minus its liabilities. The P/B ratio is calculated by dividing a company’s market capitalization by its book value.
The P/B ratio is often used by investors as an indicator of whether a stock is overvalued or undervalued. A company with a low P/B ratio may be undervalued compared to its peers, indicating that it may be a good investment opportunity. On the other hand, a company with a high P/B ratio may be overvalued, suggesting that its stock price may be too high given its assets and liabilities.
The steps to use the P/B ratio to find the intrinsic value of a stock in Indian stock markets are similar to those outlined in my previous answer. Here are the steps:
- Find the P/B ratio of the company whose stock you want to value. You can find this ratio on financial websites or in the company’s financial statements.
- Compare the company’s P/B ratio to the P/B ratios of other companies in the same industry or sector in the Indian stock market. This will give you an idea of whether the company is undervalued or overvalued compared to its peers.
- Calculate the company’s book value per share by dividing its total equity by the number of outstanding shares. You can find this information in the company’s financial statements.
- Multiply the book value per share by the P/B ratio to get the intrinsic value per share.
For example, if a company has a P/B ratio of 2 and a book value per share of INR 100, its intrinsic value per share would be INR 200 (2 x INR 100). If the current market price of the stock is less than INR 200, it may be undervalued and could be a good investment opportunity.
It’s important to note that the P/B ratio is just one of many metrics that investors use to value stocks, and it should be used in conjunction with other factors such as earnings, cash flow, and growth potential to make a more informed investment decision. Additionally, the Indian stock market may have unique considerations, such as regulatory and currency risks, that should also be taken into account.
