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What is Intrinsic Value of a Stock?

How much is a stock worth? The intrinsic value of a stock helps you answer this important question.

Now, you’ll ask that can’t we get the stock’s worth with its share price? Well, the share price of a particular stock is subject to the market volatility and other factors.

That is why analysts use intrinsic value to determine a stock’s true value. It helps determine the present value of all the distributable cash flows the company generates during its lifetime.

It refers to what a stock is actually worth even if some investors think it's worth a lot more or less than that amount.

The intrinsic value is not just for stocks, but for all asset classes.

Your estimate of a stock's intrinsic value will depend on how well you understand the company's business, its long term growth and profitability prospects.

A commonly used method for calculating the intrinsic value is the Discounted Cash Flow (DCF) method. This process involves predicting the future cash flows of a company and discounting them using the weighted average cost of capital (WACC) (debt and equity).

DCF = Future cash flows of the company/WACC

Sometimes, due to external factors, the price of a stock can deviate lower from its intrinsic value. Now, this can be a good time to buy the stock. In the long-term, the price of a stock does converge back to its intrinsic value, allowing you to profit from this temporary deviation.

An effective valuation tool, the intrinsic value metric is useful only in some cases. Unlike the P/E ratio, it can be used to value high-growth stocks that are yet to turn a profit.

For instance, a high-growth tech business is yet to turn a profit. A P/E ratio simply won’t work as there is no profit. However, an investor can predict and make estimates about the company’s future to arrive at the intrinsic value using the discounted cash flow method.

If all this is still confusing for you, we recommend you read our guide on finding the intrinsic value of a stock.

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