What is Intrinsic value? How to find it?

Podcast Duration: 05:33

Hi doston! Angel Broking ke is podcast mein aapka swagat hai!

I recently saw a video of some high school teacher trying to explain to a class of teenagers ki lockdown mein your parents might not tell you, lekin sab pe financial pressure badh gaya hai. “We all need new things like electronics, stationary and clothes lekin please abhi brand ke peeche math pado - at least during these challenging financial times, asli value ke hisaab se spend karna. Ghar pe baithe you really do not need to wear a Rs 2,000 t-shirt for your virtual classes. T-shirt toh t-shirt hi rehta hai … whether you pay Rs 250 or Rs 650 or Rs 2,500, worth of t-shirt utna hi rehta hai, toh worth ke hisab se khareed lo rather than popularity, brand etc”

Lockdown ho ya na ho, covid ho ya na ho stock market mein zaroor stocks ko worth ke hisaab se khareedna chahiye. Yeh “actual worth” ko “intrinsic value” kaha jaata hain.

Toh what exactly is intrinsic value? Let’s dive in!

Intrinsic value, sometimes referred to as real value, calculates the actual value of a company’s stock. Intrinsic value concept mein pehla assumption yeh hai ki the stock market behaves in a way that is not logical. The actual value of a stock might be A but on the stock market it could be less than A or more than A or A minus Rs 50 or A multiplied by 50. Yeh toh sahi baat hai because demand supply economics also come into play in the stock market. In fact hazaaro factors se stock price mein fluctuation hota hai

So the first thing you need to understand about intrinsic value is that it does not accept the current stock price as a real indicator of value.

Intrinsic value ke baare mein doosra most important point hai ki intrinsic value calculate karne ki kai sare tareeke hai. Alag alag financial analysts alag tareeke use karte hai. Aaj ke podcast mein we will look at some of the commonly used methods of calculating intrinsic value.

Lekin before that, you are probably wondering – stock toh stock market price par khareedna hai. What’s the point of calculating the actual value? Jab groceries khareedne jate ho toh you pay the market price of the groceries right? You don’t sit and calculate ki manufacturing cost kya thi….

Simple baat hai dost. You don’t want to pay more than the intrinsic value of the stock. If the stock is trading at an inflated price, one that is not justified by its cash flow and financials, phir stock price correction – meaning stock price drop – hone ka bada possibility hai. That means you will buy at an inflated price and the price can fall while you are holding the stock. Yeh toh smart investing ka bilkul opposite hai. You want to buy when the stock is undervalued or at least at a low price or reasonable price – so that there is room for the stock price to increase and for you to take home some earnings by selling the stock when the price is higher.

Value investors in particular, pay careful attention to the intrinsic value of a stock. Value investing strategy mein the idea is to only buy stocks that are trading at a discount, or below their actual value.

Now that you have understood intrinsic value meaning and why you need to calculate the intrinsic value of a stock, chaliye observe karte hai the two most popular calculation methods.

Qualitative model

Iss model mein financial analysts saare financial documents ko dekh kar stock ka real value calculate karte hain. The financial analyst will give weightage to various telling aspects of a company’s business. Financial statements ke alava, financial analyst investor perception ko bhi consider karte hain, the target audience of the company, the management team – bahut saare cheezein consider kiya jata hai.

Financial analyst ka difficulty yeh hai ki subjectivity decision-making mein kabhi nahi aana chahiye. Mathematical models develop kar ke, financial analysts try to keep their opinions and feelings and past experiences out of the equation.

However, some investors prefer the qualitative model kyunki; it goes beyond just hard numbers and also considers the people running the company (or running about with your money if you buy the stock).

Discounted Cash Flow model

Yeh model thoda easier hai in terms of eliminating subjectivity and relying completely on numbers. DCF model mein company ka cash flow aur WACC, meaning weighted average cost of capital use kiya jata hai.

Let’s understand these two terms to understand the DCF model!

Cash flow as you might already know is the money coming into and going out of a company (jisse pata chalta hai ki business achi tarah se chal raha hai ki nahi)

WACC is slightly more complex – it refers to the amount of capital that a company is expected to earn in the future.

Formula toh zyaada hi complicated hai. It will look something like this. We’ll use some short forms to make it easier – CF stands for cash flow and R stands for interest rate Intrinsic value = (CF1) divided by (1 + r) + (CF2) divided by the square of (1 + r)^2 + (CF3) divided by the cube of (1 + r) and so on.

Once you have got your intrinsic value, you must compare it to the actual stock price. Agar stock price intrinsic value se kam hai toh the stock price is undervalued. Agar stock price intrinsic value se zyaada hai, toh the stock price is overvalued, or its price is inflated.

So aaj ke podcast mein bas itna hi. Ab main bhi jaati hoon kuch shares ki intrinsic value ko calculate karne - milte hain next time. Tab tak ke liye, goodbye from angel broking, and happy investing!

Investments and the securities markets are subject to market risks. Read all the related documents carefully before investing.