Where have you heard of intrinsic value?

To define intrinsic value, we first need to understand value. Simply put, value is what someone is willing to pay for something. If you sell a product at too high a price point, it’s unlikely that customers will purchase it as they will believe that the price does not correspond to the value of the product. If you sell that same product at too low a price point, you may find that you sell out of stock rapidly as many of your customers will consider the product to be undervalued.

What does intrinsic value mean? In financial analysis, intrinsic value is the calculation of an asset’s worth based on various data points, which will include both technical and fundamental considerations. Let’s look at an intrinsic value example in the stock market.

Assume that you’re interested in investing your capital into Coca-Cola (KO). You believe they have a secure business model, and that their brand recognition and comprehensive product lines will produce consistent profits for the foreseeable future. You look at their stock price and notice that they are currently trading at $60 a share, say (this is just an example and not the actual price). The next question you ask yourself is whether or not $60 is a good price to pay for a share in Coca-Cola.

To determine this, you need to try to ascertain that stock’s intrinsic value. Analysts would do this by examining metrics such as the company’s debt-to-income ratio, earnings reports, assets and liabilities. Their financial models produce a valuation that you can compare against the stock’s current price. Your analyst may conclude that Coca-Cola’s stock is intrinsically worth $46 a share. In our example, with the share price of $60, Coca-Cola would be considered overvalued. You would be advised to wait for a price drop before opening a long-term position.

When it comes to investing, valuations are a common topic. You will regularly hear discussions about the valuations of popular companies, like Apple (AAPL) or Facebook (FB), while analysts furiously debate questions, like: “Is Tesla overvalued?”

Any long-term investor should be familiar with the concept of intrinsic value. Whether you invest in real estate, stocks, or cryptocurrencies, you will likely have heard the term.

What do you need to know about intrinsic value?

Intrinsic value is a subjective concept. Investors should be aware that there is no standard method to measure an asset’s intrinsic value, and methodologies will differ depending on the analyst or institution conducting the analysis.

Intrinsic value is not a fixed metric and regularly fluctuates in response to a variety of factors. For this reason, analysts will regularly update their “fair value” assessments of the assets they analyse to factor in changes in risk or future cash flows.