When you want to buy or sell stocks, you want to know if the price is fair. The intrinsic value can help you with this. In this article, you will learn exactly what intrinsic value is and how you can calculate it.
Intrinsic: a definition
Before we look at the value of a company, it is useful to know exactly what ‘intrinsic’ means. Intrinsic stands for something that comes from within: the core, the essence, what really counts.
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What is the meaning of intrinsic value?
In the financial world, intrinsic value means the actual value of a company that you find on the balance sheet. The balance sheet gives a snapshot of the total assets (such as possessions like machines, inventory, real estate, and cash) minus the liabilities (the debts). This then amounts to a company’s equity.
Extrinsic value
Extrinsic value is not the same as intrinsic value. Extrinsic value (instrumental value) is the value of an object to achieve something else. You can use it to generate intrinsic value. An example of this is a new computer. This has extrinsic value because it is a means to be more productive and increase the profitability of a company.
How do I calculate intrinsic value?
You calculate the intrinsic value by looking at the balance sheet. You add up all assets and then subtract the debts from the total assets. You use the following formula for this:
Intrinsic value = total assets – debts
An example of intrinsic value
Suppose a company owns €10 million in assets and has €4 million in debts. Then the intrinsic value is (€10 million – €4 million =) €6 million.
Intrinsic value per stock
You can also calculate the intrinsic value per stock. You do this by dividing the intrinsic value by all outstanding stocks. You use this formula:
Intrinsic value per stock = (total assets – debts) / outstanding stocks
An example of intrinsic value per stock
Let’s take the example above. The company has 1 million stocks outstanding. This means that the intrinsic value per stock is (€6 million / 1 million =) €6.
How important is intrinsic value?
The intrinsic value represents the actual value that shareholders would theoretically receive if the company were liquidated (sold) immediately and debts were paid off. This is the ‘book value’ and mainly reflects the past: historical profits, previous dividend payments, and built-up reserves come together here. For real estate funds and private equity firms, this figure is relevant because the value goes to the shareholders.
For regular companies, intrinsic value is less interesting in practice. The method does not take into account intangible assets (such as brand reputation and qualified staff) or future earning capacity, which is often the most important business value of a growing company.
The stock prices of companies with many intangible assets are often far above the intrinsic value per stock. As a result, the balance sheet does not give a good representation of the actual underlying value. To better value such companies on future results, it is important to add those intangible assets to the intrinsic value.
How do you apply intrinsic value when investing?
As an investor, you can apply intrinsic value in fundamental analysis. This gives you insight into how the market estimates the company’s future. You look at the underlying factors of a company to determine the real value and see if an investment product is over- or undervalued.
- Overvalued stock: When the intrinsic value per stock is lower than the stock price, the stock may be overvalued. In that case, investors expect the company to make significantly more profit in the future than the current value suggests, but investors selling the stock believe the price will drop in the future to come closer to the real (intrinsic) value (a possible selling opportunity).
- Undervalued stock: When the intrinsic value per stock is higher than the stock price, the stock may be undervalued. In that case, investors expect a decrease in future profits, but investors buying the stock believe the price will rise in the future to come closer to the real (intrinsic) value (a possible buying opportunity).
Intrinsic value and options
When you work with options, you will encounter the term intrinsic value again. However, it means something different. It is the direct benefit the option holder would have if they exercised the option now.
Is the price value of a call option (right to buy) at €60, for example, and is the strike price at €50? Then the positive difference is €10 (price value – strike price). Does a put option (right to sell) have a strike price of €40 and a price value of €30? Then the intrinsic value (strike price – price value) is €10.
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All views, opinions, and analyses in this article should not be read as personal investment advice and individual investors should make their own decisions or seek independent advice. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication.
