What is the intrinsic value of an asset

Intrinsic value is a measure of what an asset is worth. This measurement is arrived at through an objective calculation or a complex financial model. Financial analysts attempt to determine the intrinsic value of an asset using fundamental and technical analysis to measure its actual financial performance. Let's see how we can calculate the intrinsic value of an asset and how to put it into practice 

What is intrinsic value

Intrinsic value is a measure of what an asset is worth. This measurement is arrived at through an objective calculation or a complex financial model. Intrinsic value is different from the current market price of an asset. However, comparing it to the current price can give investors an idea of ​​whether the asset is undervalued or overvalued. Financial analysis uses cash flow to determine the intrinsic or underlying value of a company or stock. In option pricing, intrinsic value is the difference between the option's strike price and the current market price of the underlying asset.

What is intrinsic value for?

Financial analysts attempt to determine the intrinsic value of an asset using fundamental and technical analysis to measure its actual financial performance. While they can build valuation models using qualitative, quantitative, and perceptual business factors, the metric often used in intrinsic value calculations is discounted cash flows. Investors generally try to use both qualitative and quantitative factors to measure the intrinsic value of a company, but investors should keep in mind that the result is still only an estimate. Generally speaking, intrinsic value can be considered to be how much the business is worth, determined by the sale of the entire business and its assets.

How to calculate the intrinsic value of an asset

Using discounted cash flow (DCF) analysis, cash flows are estimated based on how a business can perform in the future. Those cash flows are then discounted to present value to obtain the intrinsic value of the company. The discount rate used is usually a risk-free rate of return, such as that of the 30-year Treasury bond. It can also be the company's weighted average cost of capital (WAAC).

Example of calculating the intrinsic value of an asset

As an example, we will use the profits available to investors of a company as cash flow. Let's say this figure is $200 (after adding depreciation and subtracting capital expenditures) for the last year. If you have a hypothetical P/E ratio for the S&P 500 of 15, the market value per share is $3,000 (15 x $200). We will use that figure for comparison with the intrinsic value.

1. Using an estimated growth rate of 7%, the estimated cash flow for each of the 10 years is:

Year 1: $214,00 (200 x 1,07)
Year 2: $228,98 (200 x 1,072)
Year 3: $245,00 (200 x 1,073 and so on)
Year 4: $262.16
Year 5: $280.51
Year 6: $300.15
Year 7: $321.16
Year 8: $343.64
Year 9: $367.70
Year 10: $393.43

2. We then discount these cash flows using a theoretical 30-year Treasury bond rate of 3,3%. We apply it using the discounted cash flow formula (shown above) for each year. For example, the formula for the first year is CF/1 + r. The discounted cash flow for each of the 10 years is:

Year 1: $207,16 (214/1,033)
Year 2: $214,58 (228,98/1,0332)
Year 3: $222,26 (245/1,0333 and so on)
Year 4: $230.23
Year 5: $238.48
Year 6: $247.02
Year 7: $255.87
Year 8: $265.03
Year 9: $274.53
Year 10: 284,35 The total discounted cash flow is $2439.51.

3. Then, a quick and common way to estimate terminal value is to multiply earnings in the final year of the projection period by a multiple of 15. That's $393.43 X 15 = $5897.10. That discounted amount is $4262.21 (5897.10/1.03310).
4. Finally, we combine the first 10 years of discounted cash flows with the terminal cash flow for the intrinsic value: $2439,51 + $4262,21 = $6703,72 Compared to the company's current stock price of $3000, the intrinsic value of $6701,72 indicates that the stock is undervalued and worth considering as an investment.