Table of contentsWhat is intrinsic value? — intrinsic value definitionHow to calculate the intrinsic value of a stock?How to use the online intrinsic value calculator?What is the margin of safety?How to use intrinsic value to pick the right stock?Example of intrinsic value calculation to evaluate stocksFAQs
Use the intrinsic value calculator to determine the approximate intrinsic value of growth stocks.
Do you want to invest in the stock market, but don't know where to start? Let Benjamin Graham, the father of value investing, guide you in picking profitable shares through his intrinsic value formula. Continue reading this article to learn what intrinsic value is and how to use it to pick the right company stocks. You will also find an example of intrinsic value calculation.
And next time, don't make investments based on your gut feeling or hunches. Instead, educate yourself and make informed decisions based on financial data and fundamental analysis of the company you want to invest in.
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What is intrinsic value? — intrinsic value definition
The term intrinsic value is an umbrella term covering the true worth of any asset, for example, a company's stock, etc. Benjamin Graham first introduced the idea of intrinsic value in his book, Security Analysis (1934). He insisted on doing a valuation of stocks based on the fundamental analysis of the company.
These days, financial analysts use intrinsic value to decide which stocks are good investment opportunities, using Ben Graham's intrinsic value calculation.
How to calculate the intrinsic value of a stock?
There are severalto determine the intrinsic value of stocks. However, for retail investors, it is difficult to understand these complicated models and perform complex calculations. Therefore, in this calculator, we will use a simple formula proposed by Benjamin Graham to determine the intrinsic value of a stock:
V — Intrinsic value of the stock.
EPS — Earnings per share of the company over the past twelve months. You can calculate earnings per share by dividing the company's net annual income by the number of its stocks held by all its shareholders.
8.5 — Value proposed by Benjamin Graham for the price-to-earnings ratio (P/E) of a non-growth stock. A non-growth stock is a stock that is expected to grow at a rate of 0%.
g — Company's expected growth rate for the next 7-10 years.
Later on, he revised the above formula to adapt to the changing economy and market. The revised Ben Graham formula for intrinsic value calculation is:
The additional term,
4.4, is the risk-free return rate on corporate bonds in the United States in the year 1962. To adjust/correct the formula for the present, the factor Y is introduced. It is the current AAA corporate bond yield.
How to use the online intrinsic value calculator?
Let us see how to calculate the intrinsic value of a stock using our online intrinsic value calculator.
- Enter the earnings per share of the company.
- Input the expected annual growth rate of the company.
- Type in the current AAA corporate bond yield. The current AAA corporate bond yields in the United States are about 4.22%.
- Enter the current market price of the share.
- The calculator will use the Benjamin Graham intrinsic value formula to calculate the intrinsic value per share of the stock.
- It will also show the margin of safety. It is advisable to have a margin of safety between 20% and 50%, but it also depends on your individual risk appetite.
What is the margin of safety?
When the stock market price is below its intrinsic value, the difference between the two is called the margin of safety. It is good for investors to set a margin of safety according to their risk appetite. They should only buy a stock when this difference is present to be cushioned against huge losses. The formula for calculating the margin of safety is:
- MS — Margin of safety; and
- CMP — Current market price.
You can read more about it in our margin of safety calculator.
How to use intrinsic value to pick the right stock?
Once you have determined the intrinsic value, you can compare it with the current market price. The difference between the intrinsic value and market price is a good indicator for picking stocks for long-term holding. If the market price is below the intrinsic value, you should buy the stock and hold it until the two converge. It can help you save money when building a portfolio. If a stock is overvalued, it is best to wait until the market brings it down to below its intrinsic value. This will help you in avoiding losses. It is good to buy undervalue stock and sell it when the stock market price approaches its intrinsic value.
Example of intrinsic value calculation to evaluate stocks
To get a better idea about estimating the intrinsic value of a company's stock, let us calculate it. We imagine a company ABC corp. with an annual growth rate of 10%. Let the earnings per share of this company be $23, and the current yield on AAA-rated corporate bonds be 3.7%.
The intrinsic value of this company's share is:
Now, if the current market price of the stocks of ABC corp. is $500, the company's shares are undervalued by:
Hence, it is a good idea to buy and hold these stocks.
What is intrinsic value of stock?
The intrinsic value is the actual worth or true value of a company's stock. It is calculated by taking into account a company's assets, earnings, and dividend payouts.
How do I find intrinsic value of stock?
You can find the intrinsic value of a stock using a simple formula proposed by Ben Graham:
- Determine the trailing 12 months EPS of the company.
- Multiply the company's long-term growth rate by
- Find the product of the value obtained in step 2 with the EPS of the company and a factor
- Divide the value of step 3 by the current AAA corporate bond yield, and you will get the stock's intrinsic value.
What is margin of safety?
The margin of safety is the difference between the estimated intrinsic value of a growth stock and its market price.
How do I calculate P/E ratio?
To calculate the price-to-earnings ratio, follow the given instructions:
- Determine the earnings per share (EPS).
- Find out the current stock price.
- Divide the value of step 2 by that of step 1.
- Congrats! You just calculated the P/E ratio.
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