Intrinsic ValueFinancial Dictionary -> Investing -> Intrinsic Value
How Is the Intrinsic Value Calculated?
Typically, value investors look at other variables such as copyrights, trademarks, and brand names as to get a better estimate of the asset's actual value. Another method is to look at the market capitalization or how much the investors are willing to pay. Because individuals use different techniques to calculate the intrinsic value, the number is not always the same.
In a call option, the intrinsic value is calculated as the difference between strike price and underlier price. For example, the strike price for a call option of a hundred shares is $40, and the stock trades at $60 per share. Then, the option has an actual or intrinsic value of $20 per share or a total of $2000. When the stock is traded at less than the strike price, the value is negative, and the intrinsic value is zero.
If you invest in stocks or other securities, you need to know which of them are going up and down. One of the best ways to determine if a stock is profitable is to find its intrinsic value. The latter gives you the opportunity to see the approximate worth of the stock. Valuing it may not be as easy to do, but some methods may be of help. One of the most common techniques requires compiling the EPS figures of a company and dividing the value by the discount rate or annual rate of return. Therefore, if some company has a stock earning of about $4 dollars per share, and the treasury bond has a discount rate of five percent, the estimated intrinsic value is $80 per share with regard to bonds.
How to Use the Intrinsic Value
Although the calculation of intrinsic value may seem confusing, using the estimated value to your advantage is quite easy. As soon as you get the actual value of certain stocks, you can determine the risks involved in buying or selling them. For example, if the stock (IV of $80) is trading at $50, the stock is undervalued. If it is trading at $100, then it is overvalued. Avoiding overvalued stocks is a great way to make good money from the market.
In view of real estates, intrinsic value denotes the NPV of future cash flows that individuals and businesses forgo by purchasing a real estate, rather than renting the same in perpetuity. Cash flows include property and maintenance taxes, inflation, and rent. In this case, the calculation can be done with the help of the Gordon growth model. It is a version of the discounted cash flow model which values businesses and stocks. The model is often employed to sort out difficult valuation issues in view of tax planning, litigation, and business transactions. It is assumed that a business entity issues a dividend with a current value growing at a constant rate. The required rate of return is set constant for the stock, equaling the cost of the equity. The value of price current is established by summing infinite series.