The word intrinsic comes from the latin intrinsecus meaning “inward”. In modern parlance, intrinsic means “belonging to a thing by its very nature”. The intrinsic value of a stock will thus be very personal to that stock, unique even, and will be totally unrelated to the intrinsic value of another stock. In a sense, intrinsic valuation is the art (and possibly science, depending on how analytic we are) of putting a fair value on current, and more often future returns. It is a very useful tool, and one every value investor should use.
The asset base of a company is a baseline for intrinsic value; on top of that, measured value comes from returns – what the company is doing and is likely to do with that asset base. Intrinsic valuation requires quite a few assumptions, and is never precise – projected values can be vastly different from what is expected.
On our intrinsic value screen, we use the expected growth rate for the next 5 years; how the intrinsic value is calculated is mentioned here:
Also check our intrinsic value stock screen.
Calculating intrinsic value for a stock allows us to assess future returns and risk. The value will tell us if the expected growth is sustainable; for example – Tidewater (TDW) is showing an intrinsic value of $518, with the current price at $50.18. The 5 year growth is expected to be 57% according to analyst estimates, while the industry rate is expected to be around 12% over the same period. Looking at a long-term chart of Tidewater since 1980, the highest price it reached was $71.
So, we have to ask is $518 a realistic price for TDW? But what we should be asking is: is 57% a realistic growth rate for the next 5 years? Doubtful.
In other words, we should use the intrinsic value calculation as a “reality check” while we ask lots of questions – how much growth will this company *really* see? How soon will it happen (what’s our timeframe)? How long will the company maintain the growth? Sometimes less is more…more companies can sustain lower growth rates for a longer time. These types of companies are valuable.
We also want to look for consistency in growth, not companies that engage in boom and bust growth, i.e. a smooth exponential upward curve in growth. If you find one, hang onto it.
In summary, do not use intrinsic value alone to buy stocks, but use it as a “stock tool” for sanity checks in your value investing toolbox.
{ 7 comments… read them below or add one }
A surprisingly insightful article. I generally agree. The hardest part of picking the entry and exit prices for stocks is determining the true value. I wish there was historical fundamental data like technical info.
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I noticed a heading in one of your screens, entitled “Forward Intrinsic Value”.
What is this and how do you calculate a forward intrinsic value for a stock?
You have a great, informative site.
Thank you,
Michael Kindred
Dallas, TX
Hi, Michael:
Please see this description of the intrinsic value calculation.
I use the term “Forward” to imply intrinsic value going forward, since we use the analysts’ estimated growth figure for the next 5 years.
Very nice site! I benefitted a lot from your insights.thanks!
However I have a different opinion on this matter, I mean we can’t do the individual stock picking just based on a couple of numbers and so called intrinsic formula, which is totally a guess work!
Everything you are talking about is about future,if we go back Graham’s book,the security analysis,he always pointed it out that the trend is not destiny,the everlasting upward trend of a company,no matter it is a 57% or 5 %, neither of them are fixed or guaranteed, so based on sound logic it’s not a matter of big numbers or small numbers, it is about on either present or future you are focusing.
Real estate appraisers use three different methods of analyzing and forming an opinion of value, which is all an appraisal is. The three approaches are the replacement value method, what it would cost to recreate the property as is, factoring in depreciation of improvements, the comparable sale method, looking at recent sales of comparable property and making adjustments for the variations, size quality, appeal etc of the improvements, and the income method, most often used in appraising commercial or income properties by determing the actual or expected income and assigning an appropriate multiplier (called the “cap rate” or capitalization rate) to that actual or expected income. These three approaches can give result that are tightly grouped or widely spread out. From these the appraiser forms an opinion of value.
In value investing, perhaps the equivalent is the P/E ratio (the income approach), intrinsic value (perhaps analogous to the comparable approach), and book value (perhaps a “replacement value equivalent). Some adjust book values by examining the assets on the balance sheet and making adjustments for liquidating values, removing intangibles, adjusting for peculiarities of GAAP, etc. These are all judgment calls, somewhat subjective, but designed to help form an opinion of real value, in which the appraiser has real confidence, which can then be compared to the price to determine further action.
Thank You for this great web site, it’s a great resource for those of us new to value investing.
I was wondering if anybody out there could solve this arbitrage question… I don’t have a position (though I would love to).
Northern Foods (in the process of being acquired in the UK) today it went up 17% matching the merger offer of Mr. Boparan (Chicken ticoon who supplies Tesco). Northern Food is currently the subject of takeover war between Mr. Boparan and Greencore. Nothing fancy here, Friday evening they announced their offer and pronto on Monday arbitrageurs in the UK went and bought the stock matching the offer.
Here is the question.
Northern Foods trades very thinly in the Pink Sheets, OTC Grey Market here in the US. (Some days there is no trading at all, in fact at Vanguard they told me the last trade in the US took place nov 29th 2010).
Today there was no movement whatsover in the price of the OTC.
I contacted the OTC here is their answer:
From: “Issuer Services”
Sent: Monday, January 24, 2011 7:28am
To: “Giuseppe Grillea”
Subject: RE: OTCIQ Information Request
Giuseppe,
It looks like some shares were brought into the US and started trading. This could be with or without the consent of the company. You may want to contact them to see if they extend voting rights to these US shares.
Regards,
Issuer and Information Services
What is going here? Is it possible that this has been overlooked by investors?
Feel free to email in private .
If you rearrange the intrinsic value calculation you can compute the P/V ratio from PE and PEG.
P/V = 1/ (8.5/PE + 2/PEG)
The median PEG for the market (according to fidelity) is 0.7. From this one can see that even if the PE is large, the limit of P/V for a PEG of 0.7 is 0.35. By this measure alone the market is very undervalued. I’m struggling with what to make of this and how useful intrinsic value really is, or am I missing something.