What is Intrinsic Value?

intrinsic valueIntrinsic value is a core concept of value investors seeking to uncover hidden investment opportunities.

It has traditionally been thought to lie at the heart of ethics. The intrinsic value of something is said to be the value that that thing has in itself, or for its own sake, or as such, or in its own right.”

Intrinsic value is the perceived or calculated value of a company, including tangible and intangible factors, using fundamental analysis. Also called the true value, the intrinsic value may or may not be the same as the current market value. Additionally, intrinsic value is also used in options pricing to indicate the amount that an option is in the money.

Intrinsic value can be calculated by value investors using fundamental analysis to look at both the qualitative (business model, governance and target market factors) and quantitative (ratios and financial statement analysis) aspects of a business. This calculated value is then compared with the market value to determine whether the business or asset is over- or undervalued.

The discounted cash flow (DCF) model is one commonly used valuation method to determine a company’s intrinsic value. The discounted cash flow model uses a company’s free cash flow and weighted average cost of capital (WACC), which accounts for the time value of money, and then discounts all its future cash flow back to the present day.

Options

The intrinsic value of call options is the difference between the underlying stock’s price and the strike price. Conversely, the intrinsic value of put options is the difference between the strike price and the underlying stock’s price. In the case of both call and put options, if the calculated value is negative, the intrinsic value is given as zero. Intrinsic value and extrinsic value combine to make up the total value of an option’s price. The extrinsic value, or time value, takes into account the external factors that affect an option’s price, such as implied volatility and time value.

Bitcoin & Gold

Money has only the value that is ascribed to it over time. Dig a bit deeper, however, and it becomes clear that gold itself has no intrinsic value. Its supply is limited (as is bitcoin, a strength of the digital currency), creating a relationship between supply and demand that cannot easily be manipulated.

Fiat Money

Fiat money only has value because the government maintains that value, or because two parties agree on said value. Fiat money was first introduced as an alternative to commodity-backed money. When people lose faith in a nation’s paper currency, like the U.S. dollar bill, the money will no longer hold any value.

Finance

In finance, intrinsic value refers to the value of a company, stock, currency or product determined through fundamental analysis without reference to its market value. It is also frequently called fundamental value. It is ordinarily calculated by summing the discounted future income generated by the asset to obtain the present value. It is worthy to note that this term may have different meanings for different assets.

Real Estate

In valuing real estate, a similar approach may be used. The intrinsic value of real estate is therefore defined as the net present value of all future net cash flows which are foregone by buying a piece of real estate instead of renting it in perpetuity. These cash flows would include rent, inflation, maintenance and property taxes. This calculation can be done using the Gordon model.

 


 

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