What is Intrinsic Stock Value

In the aftermath of the stock
market crash of 1929 in the early
days of the Great Depression
Benjamin Graham introduced the
concept of value investing.

By www.ProfitableInvestingTips.com

No longer would those buying and
selling stocks need to act like they
were at the casino.


With the concepts of intrinsic
value and margin of safety
Graham taught investors a
rational means of investing in
stocks.


With this in mind just what is
intrinsic stock value?


And how does this concept help
with profitable stock investing?


The dictionary definition of intrinsic
stock value is its fundamental
value.


It is obtained by adding up
predicted future income of a
stock and subtracting current
price.


It can also be seen as actual
value of an equity versus its book
value or market value.


The concept of fundamental
analysis of equities evolved from
this concept.


Using fundamental analysis the
intrinsic value of a stock is the
expected company cash flow
discounted to current dollars.


It is a discounted cash flow
valuation.


An inherent weakness in this
concept is that too often the
medium and long term prospects
of a company and its stock price
are not clear.


So, what is intrinsic stock value of
a company if the future is
uncertain?


The ability to see into the future to
see how well a company will
manage its assets, products, costs,
R&D, and marketing is of utmost
importance in calculating intrinsic
stock value as a means of
deciding whether or not to
purchase a stock.


Mr. Graham presented investors
with a formula for calculating
intrinsic stock value in 1962 and
modified it in 1974. The 1974
version considers the following:


Earnings per share, EPS, for the preceding
twelve months.
A constant of 8.5 representing an expected
price to earnings ratio, P/E ratio, for a company
that is not growing.
A constant of 4.4 which was the average yield
of high grade corporate bonds in the early 1960
decade.
The current yield of AAA corporate bonds = Y.
Where V = intrinsic value.


The formula is as follows:

V = (EPS x (8.5 + 2g) x 4.4)/Y


The way the investors were
encouraged to use intrinsic value
was to derive what is referred to
as a Relative Graham Value, RGV.


This is to divide the calculated
intrinsic value of the stock by its
current price.


If the result, the RGV, is less than
one the stock is overvalued and a
bad investment and if the ratio is
above one it is undervalued and
may be a good investment.


There are a couple of difficulties in
using the simple calculation
above to determine the forward
looking earnings of a stock and
therefore its intrinsic value.


First of all the formula does not
account for inflation.


Thus one could use the formula
and end up with a stock valued
higher in dollars but in dollars that
are inflated.


The second problem is more to
the point. How does one see the
future of a stock? Stocks and
stock markets rise and fall.


Thus investors astute at finding the
margin of safety of a stock protect
themselves against market
fluctuations that can damage
investments based on a simple
calculation of intrinsic stock value.


For more insights and useful
information regarding investments
and investing, visit

www.ProfitableInvestingTips.com.

What is Intrinsic Stock Value

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