Intrinsic value theory asserts that a stock's true worth is inherent in the business itself, regardless of market or book values, and is an approximation of its future performance. Intrinsic value per share is a business' intrinsic value divided by the number of shares it has issued. One method of calculating a firm's intrinsic value is to figure its discounted cash flow (DCF). A firm's DCF is a projection of its future cash flow that is expressed in current dollars. Other measures of intrinsic value include variables such as trademarks, brand names and copyrights.
1. Review a company's financial statements, which are available from the Securities and Exchange Commission (SEC) if the company is publicly traded. Private companies are not required to disclose financial data. Consult market research firms such as Moody's Analytics, Morningstar, or SNL Financial for further data regarding the firm's cash flow and other projections.
2. Determine a time frame for which you want to calculate intrinsic value. Financial projections are estimations that become less-reliable over extended periods of time, so consider limiting your projections to 10 years or less when gathering data. Exact calculations of intrinsic value are nearly impossible to reach, but close approximations can still help investors value a stock.
3. Record the necessary data to figure the company's DCF using a computer spreadsheet. Identify the company's annual cash flow projections for each year for which you are calculating DCF, as well as its weighted average cost of capital (WACC). WACC is the return a firm's creditors require when lending the firm money.
4. Create a fraction for each year that will make up your calculation of a firm's DCF. The numerator of the fraction is the firm's projected cash flows for that year, and the denominator is the firm's WACC plus 1. Before dividing the denominator, raise the sum of WACC plus 1 to a power equivalent to the corresponding year. For example, the denominator for year three is (WACC + 1) to the third power.
5. Sum the quotients of each fraction to arrive at the firm's DCF. To arrive at intrinsic value per share, divide DCF by the number of shares the firm has issued, which is recorded in the firm's financial statements. If a firm's DCF is lower than its current price per share, the disparity could indicate an undervalued stock.
6. Estimate a firm's intrinsic value using other performance measurements to project its future performance. Financial projections and estimations of intrinsic value are more of an art than a hard science. Because of this, additional measures of intrinsic value, such as exemplary creative talent or an exclusive patent, help to round out your overall evaluation of a stock's intrinsic value per share.
- Some websites and computer spreadsheets have calculators that simplify figuring DCF, intrinsic value and other financial indicators. You can utilize them to ease your calculation process.
- Many investors, such as Warren Buffett, have their own paradigm for analyzing a stock's intrinsic value. Consider developing your own in order to customize your quantification of a stock's intrinsic value.
Items you will need
- Financial statements
- Computer spreadsheet
- John Rowley/Digital Vision/Getty Images