How to calculate intrinsic value of a stock? know about the formula popularised by Warren Buffett

If you are Investing & buying any assets like stocks, MF, Gold, Real Estate or Crypto, then you must have heard about a term called Intrinsic Value. The formula was opularized by Warren Buffett, one of the greatest investor in world. He always picks stocks when the business is available at its intrinsic Value. 

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Now What Is Intrinsic Value? 

Intrinsic value is nothing but quite similar to the MRP. Like we buy any product, any medicine or any dairy product or any device like phone, tablet, laptop etc always there is MRP mentioned in the product, which tells us about the maximum retail price i.e. the maximum price to buy that product. But in stocks, there is no such concept present or exists, but there is a formula to decode it which will help you to discover the MRP of any stock. 

To summarize, intrinsic value is the MRP of any stock. It is the fair value of any business. Some investors also called it as absolute value of the business. 

Key difference between Intrinsic value & market price 

In stock market the prices of stocks are determined on the basis of demand and supply. Therefore, the price of every stock changes every business day, but the intrinsic value of any stock is determined by its fundamentals. Hence it doesn’t change that very often and remains same I always think “rationality of value doesn’t always reflect in prices of stocks. 

These makes stocks undervalued & overvalued. 

1) When Intrinsic Value is greater than Market price that means stocks is Undervalued & investors will look at it as an opportunity to buy that stock. 

2) When Market price is greater than Intrinsic value that means the stock is overvalued and it is not the good time to invest in it. 

How to calculate Intrinsic Value of any stock? 

According to Warren Buffett, intrinsic Value can be defined simply as the discounted value of cash that can be taken out of business during its remaining life. 

It can be calculated by using DCF model (discounted cash flow) 

For example, Suppose ABC stock is available at Rs 200 & using DCF model the intrinsic value comes out to be Rs 250, that means it’s a great time to buy that business as it is available in discount compared to its Intrinsic value. 

Formulae to Calculate 

I.V = FCF1 / (1+WACC) +FCF2/(1+WACC)2 + --- +FCF∞/(1+WACC)∞ 

Where 

FCFF = Free cash flow of business 

WACC =Weighted Average cost of capital (WACC) CONCLUSION 

Finding the Intrinsic Value of stocks before investing is an important thing as it helps you to assess whether you are buying an undervalued or overvalued stocks. Though calculating IV may not be a guaranteed way of mitigating losses but it discloses the financial health of business 

Picking stocks below their IV can help Investors for building the best portfolio, while it also helps investors to avoid picking stocks which are overvalued. 

(Author: Ankit Yadav, Chartered Wealth Manager (USA) & Director of Market Maestro Pvt. ltd.)

(Disclaimer: The views/suggestions/advice expressed here in this article are solely by investment experts. Zee Business suggests its readers to consult with their investment advisers before making any financial decision.)