Stock trading is not based on feelings or empty predictions. Therefore, you need to understand how to calculate the intrinsic value of a stock, in addition to knowing its true value. The reason for this is that the intrinsic value of stocks is very useful for predicting future price changes.
What is the intrinsic value of stocks?
The intrinsic value or new value of a share is the estimated value calculated from risk and return. This intrinsic value differs from market value or stock price and also from book value or equity.
In the intrinsic value of stocks, we consider the value of visible assets such as equity and invisible assets such as the company’s big name, development prospects and others. Therefore intrinsic value allows it to be subjective. Simply put, when multiple investors attribute intrinsic value to a stock, the answer will be different.
What is the intrinsic value function?
For potential stock buyers, a stock’s intrinsic value can be referred to as its true worth. The actual value or the value listed in a report, for example in a stock trading application, is a value that cannot indicate potential profit. That is, intrinsic value serves to show investors’ potential gain.
Why do you need to know the intrinsic value of stocks?
Calculating the intrinsic value of stocks is very important for investors. It is used to determine which stock price has the highest discount and is potentially the most profitable. That said, knowing a stock’s intrinsic value is useful for fundamental analysis.
In conducting the analysis, several estimates of stock prices are obtained. Some of these reviews are:
- fair value
If his calculation shows that the intrinsic value is lower than the actual value or the publicly announced value of the shares, it can be concluded that the share price is too high. The high share price can be used quickly and in groups for transactions, so the price can also fall quickly.
Therefore, overvalued conditions are unfavorable for a long-term investment. Overvalued signals that the price will fall in the future. In fact, stocks are generally used as long-term investments.
In general, share prices tend to be volatile and carry a high level of risk, making them unsuitable for short-term investments. This differs from some money management tools like peer-to-peer lending, which can produce results faster. The scheme is easier to understand even for inexperienced wealth managers.
Modal Rakyat is a peer-to-peer lending platform that offers lenders up to 18% profit per year. With a capital insurance of up to 95%, the risks of the investors are relatively safe. Therefore, this money management tool is suitable for young people or common people.
If a stock’s intrinsic value is calculated to be higher than its actual value, then the stock price is fairly low and has good fundamentals. Rising share prices are to be expected in the future. This type of trait is the trait that is chosen for long-term investments.
3. Time Value
The intrinsic value of a share can correspond to its actual value. This means that the market price is proportional to the fundamental value of the stock.
How to calculate the intrinsic value of stocks
The intrinsic value of a stock can be determined using some of the simplest methods. The use of some of these methods varies from company to company. This means that one company uses a different calculation method with another company and may make mistakes for investors.
Therefore, before calculating the intrinsic value of a stock, there are a few points to consider. Some of the things an investor should understand before buying any asset are:
- Adequacy of the valuation method with the business model
- Know the type of assessment
- know corporate profit
1. Adequacy of the valuation method with the business model
When determining how the intrinsic value of a stock is calculated, the business model should be considered. For example, to determine the intrinsic value of a stock with a telecom business model, an EV/EBITDA analysis would be more appropriate. Meanwhile, the technology business model becomes more precise when calculated using the EV/user score.
2. Knowledge of the valuation type
There are at least two types of assessment that are commonly used, namely the absolute and the relative rating. Absolute Kalosi only considers various factors related to the company’s fundamentals. Meanwhile, absolute valuation takes into account free cash flow (FCF), discounted cash flow (DCF), and dividend discounted model (DDM).
3. Know the company’s profit
It is an important point to know the earnings value of a company that is reported, at least you know if the earnings are negative or positive. If it is negative, the intrinsic value cannot be determined using an earnings-based valuation method. Because later the ratio of share price and earnings per share is calculated.
Now that you know some of the key points above, you can use some common and simple formulas to determine how a stock’s intrinsic value is calculated. Some of these formulas are:
- The intrinsic value of stocks based on a dividend growth model
- The intrinsic value of stocks using the relative method
- The intrinsic value of Benjamin Graham’s stock
1. Intrinsic value of stocks based on a dividend growth model
he distribution of dividends or company profits to shareholders can be used to calculate the intrinsic value of a stock. To use this calculation method, you need to know how many dividends are paid in a period. Some stock terms to understand when using this calculation method are:
A = dividend payment period
B = total dividend
C = constant value of discount rate
The calculation formula is: A = [B1/(1+C) + [B2/(1+C) + etc.
Example: A company distributes dividends from periods 1-8 of Rp 30, Rp 20, Rp 23, Rp 30, Rp 26, Rp 28, Rp 30 and Rp 34. It is also known that the discount rate is constant at 5%. What is intrinsic value?
A = [B1/(1+C)] + [B2/(1+C)] + etc
= [30/(1+5%)] + [20/(1+5%)] + [23/(1+5%)] + [30/(1+5%)] + [26/(1 +5%)] + [28/(1+5%)] + [30/(1+5%)] + [34/(1+5%)]
Then the intrinsic value of the shares is Rp. 176.89.
2. Intrinsic value of stocks using the relative method
The relative method of calculating a stock’s intrinsic value is one of the simplest. In this method, the following terms must be understood:
EPS = earnings per share based on the annual report.
PER = Price Earnings Ratio
The formula used is Intrinsic Value = EPS X PER
Example: A company states that its estimated earnings per share for the next year is Rp. 225. Her PER is now estimated to be 12 times higher. How to calculate intrinsic value:
Intrinsic Value = EPS X PER
= 225 x 12
3. The intrinsic value of Benjamin Graham’s stock
Some terms to consider when calculating the intrinsic value of a stock using Benjamin Graham’s formula are:
V = intrinsic value
EPS = earnings per share or earnings per share based on the annual report.
8.5 = base P/E
g = expected growth (in percent)
4.4 = return on an investment with low risk or no risk
AAA = interest on long-term debt instruments.
The formula for intrinsic value is expressed as V = EPS x (8.5 + 2g)
The intrinsic value of Benjamin Graham’s stock house has a modification with a more detailed calculation, namely: V = EPS x (8.5 + 2G) x (4.4/AAA)
Example: A company’s stock is priced at Rp. 6,700 per share. Meanwhile, it is known that EPS value is 558, estimated growth is 15%, 4.4 based on 6.5% BI interest rate and 12% AAA. So its intrinsic value is?
V = EPS x (8.5 + 2g) x (4.4/AAA)
= 558x (8.5 + 2×15) x (5.75/12)
In comparison, the actual price of the shares is Rp 6,700 while the intrinsic value is Rp 8,092. Its status is therefore overrated and is more suitable as a short-term investment.