Intrinsic Value Method of Shares

This is also known as Balance Sheet Method or Net Asset Method or Break-up Value Method or Valuation of Equity basis or Asset Backing Method. Here the emphasis is on the safety of investment as the investors always need safety for their investments. Under this method, net assets of the company are divided by the number of shares to arrive at the net asset value of each share.

The intrinsic value of a business (or any investment security) is the present value of all expected future cash flows, discounted at the appropriate discount rate. Unlike relative forms of valuation that look at comparable companies, intrinsic valuation looks only at the inherent value of a business on its own.

It is true that technical analysis helps you predict how the stock price is going to move and what price levels it may touch. However, the price is still very closely linked to the intrinsic value of the stock. So, technical analysis only helps determine the direction and the extent of the stock price movement.

For prices to move in a particular direction, they must first start from somewhere. Let’s say the price of a stock is Rs 150 right now. Your technical analysis suggests that it will go up to say, Rs 175. But where did the current price of Rs 150 come from? There is a method for calculating it.

The following points may be borne in mind:

(1) The value of goodwill will be ascertained.

(2) Fixed assets of the company, disclosed or undisclosed in Balance Sheet, are taken at their realisable values.

(3) Floating assets are to be taken at market value.

(4) Remember to exclude fictitious assets, such as Preliminary Expenses, Accumulated Losses etc.

(5) Provision for depreciation, bad debts provision etc. must be considered.

(6) Find out the external liabilities of the company payable to outsiders including contingent liabilities.

Thus the value of net asset is:

Net Assets (Intrinsic value of asset) = Total of realisable value of assets – Total of external liabilities

Total Value of Equity shares = Net Assets – Preference share capital

Value of one Equity share = Net Assets – Preference share capital/Number of Equity shares

Advantages of Intrinsic Value

The primary intention of value Investing is to discover such stocks that are trading for lesser than the intrinsic value. Although there is no specific intrinsic value method of figuring out this value; however, the basic idea is to purchase stocks by spending less than their real worth. And, nothing but assessing intrinsic value can help you with that.

Intrinsic Value Different From Market Value

Following are the reasons why the intrinsic value is different from the market value of a stock:

• An investor may not have all the relevant information for valuing a company’s stock.
• Different investors have different information and market price may be perceived as the weighted average of all the information of investors.
• A company does not disclose everything in public in order to protect the information from reaching to its competitors. If confidential information is shared, the competitors can take strategic advantage out of the information.
• Thoughtful misguidance by the management of the company due to agency problems. Agency problems mean the non-congruence between the goals of investors and management of a company.