Intrinsic Value


Defining intrinsic value

In looking at intrinsic value, is that it values what can be taken out of the business. Investment guru John Burr Williams who defined value like this:

The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset. – The Theory of Investment Value.

Intrinsic Value Learning How to Invest and Value an Asset

  • In intrinsic value you value an asset based upon its intrinsic characteristics or properties
  • For cash flow generating assets, the intrinsic value is a function of the magnitude of the expected cash flows received on the asset over the lifetime and discounted for the uncertainty about receiving those cash flows.
  • Very Basic Intrinsic Value Calculation methods Like Benjamin Graham’s Intrinsic Value,or Benjamin Graham’s Number. These formulas are very simplistic but understanding them and the principals is a very good start.
  • Discounted cash flow valuation is one of many tools for estimating intrinsic value, where the expected value of the asset is the current cash flows wirten as present value and future cash flows discounted by the discounted rate to reflect risk

Metrics for value are only as good as their input like any mathematical formula BS IN BS OUT!

The fundamental determining elements of value

  • What are the cashflows from existing assets?
  • What is the value added by growth assets?
  • How risky are the cash flows?
  • What are the growth metrics? How quickly is the company growing? When will the firm become a mature firm and what are the road blocks? Discount for them.

Special cases for valuation

Valuing stable companies with consistent and clear accounting statements and long histories and many comparable businesses is easy.

  • Immature and Young Companies – Companies with non existant cash flows and difficult to project futures or businesses. It’s very difficult to value new businesses but it can be even more difficult when the business is doing business in a new arena and has very few or only very immature comps.
  • Companies that don’t fit accounting mold (Businesses that have collections of businesses of varying maturties). An example would be Netflix which has a very profitable Domestic business and a very immature International business. If you just net out the Domestic with the losses of the International then true value is hidden or Amazon which is also a collection of businesses of varying degrees.
  • Companies that face substantial risk (default, truncation)
    • Mature companies in transition
    • Declining and Distressed Firms
  • Sector risk
    • Financial Services Firms – Work backwards. Banks and Insurance companies can be identified via metrics such as Price to Book and Price to Earnings and then to try to “kill the investment”. The market is often right but your job is to find ones the market is discounting due to irrational fear.
    • Commodity and Cyclical Firms
    • Firms with Intangible Assets – Intellectual Property, Patents, Brand Names

Metrics for evaluation of a corporation

  • Return on Equity – Valuable metric for use in evaluating Financial Services and Insurance companies and more mature companies over longer periods of time
  • Retained Earnings – A companies ability to reuse retained earnings is an excellent metric for more mature businesses of its ability as a steward of capital. If a company can not efficiently use your money it should return it to you so you can do something else with it.
  • Owners Earnings – As an investor it’s great to think of an investment as if you owned the whole thing. What would be my Owner’s Earnings?

InvestCorrectly Learning How to Invest Series