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What is Intrinsic Stock Value?
In the aftermath of the stock market crash of 1929 in the early days of the Great Depression Benjamin Graham introduced the concept of value investing. No longer would those buying and selling stocks need to act like they were at the casino. With the concepts of intrinsic value and margin of safety Graham taught investors a rational means of investing in stocks. With this in mind just what is intrinsic stock value? And how does this concept help with profitable stock investing?
What Is Intrinsic Stock Value?
The dictionary definition of intrinsic stock value is its fundamental value. It is obtained by adding up predicted future income of a stock and subtracting current price. It can also be seen as actual value of an equity versus its book value or market value. The concept of fundamental analysis of equities evolved from this concept. Using fundamental analysis the intrinsic value of a stock is the expected company cash flow discounted to current dollars. It is a discounted cash flow valuation. An inherent weakness in this concept is that too often the medium and long term prospects of a company and its stock price are not clear. So, what is intrinsic stock value of a company if the future is uncertain? The ability to see into the future to see how well a company will manage its assets, products, costs, R&D, and marketing is of utmost importance in calculating intrinsic stock value as a means of deciding whether or not to purchase a stock.
What is Intrinsic Stock Value as a Formula?
Mr. Graham presented investors with a formula for calculating intrinsic stock value in 1962 and modified it in 1974. The 1974 version considers the following:
• Earnings per share, EPS, for the preceding twelve months
• A constant of 8.5 representing an expected price to earnings ratio, P/E ratio, for a company that is not growing
• An estimate of long term growth, five years = g
• A constant of 4.4 which was the average yield of high grade corporate bonds in the early 1960 decade
• The current yield of AAA corporate bonds = Y
• Where V = intrinsic value
The formula is as follows:
V = (EPS x (8.5 + 2g) x 4.4)/Y
The way the investors were encouraged to use intrinsic value was to derive what is referred to as a Relative Graham Value, RGV. This is to divide the calculated intrinsic value of the stock by its current price. If the result, the RGV, is less than one the stock is overvalued and a bad investment and if the ratio is above one it is undervalued and may be a good investment.
What is Intrinsic Stock Value as an Investing Tool?
There are a couple of difficulties in using the simple calculation above to determine the forward looking earnings of a stock and therefore its intrinsic value. First of all the formula does not account for inflation. Thus one could use the formula and end up with a stock valued higher in dollars but in dollars that are inflated.
2. In the aftermath of the stock
market crash of 1929 in the early
days of the Great Depression
Benjamin Graham introduced the
concept of value investing.
By www.ProfitableInvestingTips.com
3. No longer would those buying and
selling stocks need to act like they
were at the casino.
By www.ProfitableInvestingTips.com
4. With the concepts of intrinsic
value and margin of safety
Graham taught investors a
rational means of investing in
stocks.
By www.ProfitableInvestingTips.com
5. With this in mind just what is
intrinsic stock value?
By www.ProfitableInvestingTips.com
6. And how does this concept help
with profitable stock investing?
By www.ProfitableInvestingTips.com
8. The dictionary definition of intrinsic
stock value is its fundamental
value.
By www.ProfitableInvestingTips.com
9. It is obtained by adding up
predicted future income of a
stock and subtracting current
price.
By www.ProfitableInvestingTips.com
10. It can also be seen as actual
value of an equity versus its book
value or market value.
By www.ProfitableInvestingTips.com
11. The concept of fundamental
analysis of equities evolved from
this concept.
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12. Using fundamental analysis the
intrinsic value of a stock is the
expected company cash flow
discounted to current dollars.
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13. It is a discounted cash flow
valuation.
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14. An inherent weakness in this
concept is that too often the
medium and long term prospects
of a company and its stock price
are not clear.
By www.ProfitableInvestingTips.com
15. So, what is intrinsic stock value of
a company if the future is
uncertain?
By www.ProfitableInvestingTips.com
16. The ability to see into the future to
see how well a company will
manage its assets, products, costs,
R&D, and marketing is of utmost
importance in calculating intrinsic
stock value as a means of
deciding whether or not to
purchase a stock.
By www.ProfitableInvestingTips.com
18. Mr. Graham presented investors
with a formula for calculating
intrinsic stock value in 1962 and
modified it in 1974. The 1974
version considers the following:
By www.ProfitableInvestingTips.com
19. Earnings per share, EPS, for the preceding
twelve months.
A constant of 8.5 representing an expected
price to earnings ratio, P/E ratio, for a company
that is not growing.
A constant of 4.4 which was the average yield
of high grade corporate bonds in the early 1960
decade.
The current yield of AAA corporate bonds = Y.
Where V = intrinsic value.
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20. The formula is as follows:
V = (EPS x (8.5 + 2g) x 4.4)/Y
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21. The way the investors were
encouraged to use intrinsic value
was to derive what is referred to
as a Relative Graham Value, RGV.
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22. This is to divide the calculated
intrinsic value of the stock by its
current price.
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23. If the result, the RGV, is less than
one the stock is overvalued and a
bad investment and if the ratio is
above one it is undervalued and
may be a good investment.
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25. There are a couple of difficulties in
using the simple calculation
above to determine the forward
looking earnings of a stock and
therefore its intrinsic value.
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26. First of all the formula does not
account for inflation.
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27. Thus one could use the formula
and end up with a stock valued
higher in dollars but in dollars that
are inflated.
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28. The second problem is more to
the point. How does one see the
future of a stock? Stocks and
stock markets rise and fall.
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29. Thus investors astute at finding the
margin of safety of a stock protect
themselves against market
fluctuations that can damage
investments based on a simple
calculation of intrinsic stock value.
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30. For more insights and useful
information regarding investments
and investing, visit
www.ProfitableInvestingTips.com.
