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Tip of the Day Stocks are High Risk, High Reward

Stocks are High Risk, High Reward - Stocks when used properly and taken out on a long-term basis usually return more than more investments in dividends, although are really risky...

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Intrinsic Stock Value

When it comes to investing, everyone wants to know what stocks are going to go up. Unless you have the ability to see into the future, you'll have to settle for doing things the old fashioned way: by research them. Even though it may not be possible to be right on all of your stock picks, you can tilt the odds in your favor by learning as much as you can about the stocks you're investing in. One useful tool that you can use to make an educated decision on whether or not to buy a stock is the intrinsic value, which gives you an idea of approximately what the stock is worth.

Valuing a stock is not always very easy to do. Ratios like the P/E ratio give you a quick idea but it doesn't go into depth very well. The intrinsic value makes up for some of what the P/E ratio lacks by accounting for its growth rate and the discount rate. The growth rate allows the intrinsic value (IV) to value the stock not only on their current earnings per share but also on their future earnings per share. The term "discount rate" refers to the rate that you would have to earn to make an investment worth the risk. By accounting for this, it helps weed out some stocks that may be less lucrative investments.

Calculating the Intrinsic Value

There are actually a few different ways to calculate the IV but we'll just go over the most common method. To get started, you must first gather the company's EPS figures. You then take this number and divide it by the annual return of the investment you are comparing it with (discount rate). For example, if XYZ stock has $3.46 in earnings per share and you want to compare it with 6% treasury bonds, you simply divide 3.46 by .06 to get an intrinsic value of 57.66. This means that XYZ stock has an intrinsic value of 57.66. So this means that, relative to government bonds, the stock is "worth" about $58 per share.

That example only takes into consideration the stock's current earnings. If you are interested in finding out what the stock will theoretically be worth next year, you just substitute next years expected EPS with the current one. So if XYZ stock is expected to earn $3.90 per share next year, you divide 3.90 by .06 which gives you an intrinsic value of $65, relative to government bonds.

Calculating the intrinsic value seems pretty complicated and if you don't like doing all of the math, you can cheat by using Quicken.com's evaluator to have it figure the IV for you.

Using the Intrinsic Value

I know all of this sounds pretty confusing but, trust me, it really isn't. Calculating the intrinsic value is probably the most confusing part. Using it is actually pretty easy. Now that you know what the stock is "worth", you can compare its current stock price with its intrinsic value to decide if it is worth the risk. For example, if XYZ was trading at $45, you would consider it undervalued because its trading at a price that is less than its IV of $58. However, if it was trading at $75 per share, it would be considered overvalued.

The only big disadvantage that the intrinsic value has is that it doesn't allow you to calculate it for stocks that don't have positive earnings. So if you were hoping to figure out the value of that hot new internet stock, you might want to use another method. But, in general, the intrinsic value has very nice advantages over other methods and I've even found it more accurate. By using it, you give yourself one more way to check out a stock to decide if it really is worth the risk.

Discuss It!
1 2 >

Cedric said:

Why would I use IV in procurementt functions of acquistions of goods or services

Cedric said:

can you elaborate please?

arvind said:

what is intransic value ? is the the present value of future cash flow and the present vale of stock.

c said:

intrinsic value is an estimate of a securitys "true" value based on accurate risk and expected return data. The intrinsic nalue can be estimated but not measured precisely. The reason, its unobservable and it has to be estimated.

sam said:

If you don't estimate the intrinsic value of a stock you will never know if you are over or underpaying.

vikas said:

what are the objectives and scope of finding the intrinsic value

Tarun said:

This is not Exactly the Intrinsic Value Formula,Which varies from person to person.It is merely actually EARNING YIELD comparison with Risk free Assets yield.

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Rolex Air-King Swiss said:

you just substitute next years expected EPS with the current one.its unobservable and it has to be estimated.

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The most important thing you must consider before you are going to start a business is the stock value. It is an important concept in the business. so be careful in knowing this concept. Please make sure to be aware of it.

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