Intrinsic Value of Stock or Share: Definition and How to Calculate It
Intrinsic Value of Stock or Share: Definition and How to Calculate It
Introduction to Intrinsic Value
If you are an investor or actively involved in the stock market, the term Intrinsic Value is one you’ve likely heard often. But what exactly does it mean? Simply put, every share has two values — its market value and its intrinsic value. The intrinsic value of a stock refers to the true worth of that company based on its fundamentals, performance, and future potential, rather than its current market price.
In this article, we’ll understand:
What is the intrinsic value of a stock?
Why it matters to investors
The formula and methods used to calculate intrinsic value
How to calculate it easily and accurately
What Is Intrinsic Value?
The Intrinsic Value of a stock is the actual worth that can be estimated through financial analysis rather than market speculation. It’s determined by evaluating the company’s fundamentals—like earnings, cash flow, growth prospects, and assets—and discounting them to their present value.
For example: If a stock is trading at ₹200, but its intrinsic value is ₹250, it means the stock is undervalued and could be a good investment. However, if the intrinsic value is ₹150, it means the stock is overvalued and might not be worth buying at its current price.
Why Intrinsic Value Matters
Knowing a stock’s intrinsic value helps investors make smarter and more disciplined decisions. Here’s why it’s important:
Helps identify undervalued stocks with long-term potential
Protects investors from buying overvalued shares
Encourages rational, data-based investing instead of emotional decisions
Forms the foundation of value investing, a strategy popularized by Warren Buffett
How to Calculate the Intrinsic Value of a Stock
There are several ways to calculate the intrinsic value of a stock. Here are the most common and effective methods:
1. Discounted Cash Flow (DCF) Method
The DCF Method estimates the present value of a company’s expected future cash flows.
Formula:
[ IV = \sum \frac{CF_t}{(1 + r)^t} ]
Where:
CF = Expected future cash flows
r = Discount rate (required rate of return)
t = Number of years
In simple terms, you estimate future cash flows, discount them to present value, and sum them up to find the intrinsic value.
2. Dividend Discount Model (DDM)
The DDM applies to companies that pay regular dividends. It calculates the present value of future dividends.
Formula:
[ IV = \frac{D}{r - g} ]
Where:
D = Expected annual dividend per share
r = Required rate of return
g = Dividend growth rate
Example: If a company pays ₹10 as an annual dividend, expects 5% growth, and requires a 12% return: [ IV = \frac{10}{0.12 - 0.05} = ₹142.85 ]
3. Earnings Multiplier (P/E Ratio) Method
This simple method connects Earnings Per Share (EPS) and the justified P/E ratio.
Formula: [ IV = EPS × P/E ]
Example: If a company’s EPS is ₹20 and its justified P/E ratio is 15, [ IV = 20 × 15 = ₹300 ]
4. Asset-Based Valuation
This method calculates value based on a company’s assets and liabilities.
Formula: [ IV = \frac{Total Assets - Total Liabilities}{No. of Shares} ]
It’s particularly useful for asset-heavy sectors like real estate, banking, and manufacturing.
Intrinsic Value vs Market Value
Factor
Intrinsic Value
Market Value
Meaning
Determined by fundamental analysis
Determined by demand & supply
Basis
Company’s earnings, assets, and growth
Market sentiment and trading trends
Stability
Stable over time
Fluctuates daily
Investor Use
Helps identify undervalued or overvalued stocks
Reflects current trading price
Risks in Calculating Intrinsic Value
While intrinsic value is crucial, calculating it comes with challenges:
1. Assumption Risk
Intrinsic value relies on estimates like cash flow, growth rate, and discount rate. Wrong assumptions can distort the result.
2. Market Sentiment Risk
Investor emotions and market conditions can cause a stock’s market price to deviate widely from its intrinsic value.
3. Economic & Policy Risk
External factors like inflation, interest rates, or government policies can impact a company’s fundamentals.
4. Data and Calculation Risk
Methods like DCF require accurate financial data. Small changes in inputs can lead to large variations in the final value.
5. Dynamic Business Environment
As businesses evolve, today’s valuation may not hold tomorrow. Regular review is essential.
How to Reduce These Risks
Use multiple valuation methods (DCF, DDM, P/E, Asset-Based) instead of relying on one.
Maintain a margin of safety—invest only when intrinsic value is 20–30% higher than market price.
Re-evaluate valuations periodically as new financial data emerges.
Consider qualitative factors like management quality, brand value, and competitive edge.
Key Takeaways
Intrinsic Value is an estimated true worth of a stock.
Buy when Intrinsic Value > Market Price (Undervalued).
Avoid when Intrinsic Value < Market Price (Overvalued).
Combine multiple valuation methods for better accuracy.
Always invest with a margin of safety.
Conclusion
The Intrinsic Value of a stock represents its real worth, independent of daily market fluctuations. For smart investors, understanding intrinsic value helps distinguish between short-term hype and long-term opportunity. Before investing, always compare the market price with intrinsic value. Doing so not only minimizes risk but also strengthens the foundation for sustainable wealth creation over time.
