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How to Calculate Intrinsic Value: The Most Comprehensive Guide! (Updated 2017)

This is an advanced guide on how to calculate Intrinsic Value of a company with detailed interpretation, analysis, and example. You will learn how to use the DCF formula to estimate the value of a company.

What you will learn in this post:

  • The #1 well-known method for calculating intrinsic value of a stock
  • The complete 6-step guide on how to perform a discounted cash flow (DCF) analysis with detailed explanations and examples
  • The intrinsic value formula that you can immediately use to perform your stock valuation (infographic)
  • How to use our intrinsic value calculator to automate your valuation process
  • The real key to your value investing success

I've now been investing for several years and I'm a big fan of value investing. I remember the first days and the worst days trying to find out how to calculate intrinsic value of a stock.

I was in the same boat as you guys, wondering why investing was so hard for me. I knew there were various ways, tips and workable techniques out there. But, to be honest, I couldn't figure out which one to follow.

Guys, I really do understand just how frustrating it is for you now to find a method that really works. So, let me help you stick it out.

More...

intrinsic-value-case-study-optin

But, before we move on, I want to clarify that every investor will come up with a different intrinsic value. This depends on which valuation method they are using.

I'm not saying that my method is foolproof and those of others are incorrect. However, the technique that I'm going to teach you is the same that we teach in our investing courses.

This method works well for me, my friends and all of our students, and we believe that it will work for you, too.

What is Intrinsic Value of a Stock?

​Why is finding the actual value of a company is SO important?

Before answering this question, I need to make sure you understand clarify what "intrinsic value" actually is.

So, what's it?​

what is intrinsic value

When you invest in a company, the price that you pay for owning its shares is considered a "market price". This is the price at which the stock is currently selling.

Intrinsic value is a real or true value of that business. It can be higher or lower than the current market price. Ultimately, this value represents how much the business is actually worth.

So why is estimating this value so important, especially when you are simply a value investor?

  • You are not a real investor if you don't know how to estimate the true value of your stock.
  • Frequently performing stock valuation will help you understand much better about the business in which you are looking to invest.
  • By determining whether a company is under or overvalued, you can fully take advantage of the value investing approach to "buy low" and then "sell high", ultimately making a good profit from your investment.

How To Calculate Intrinsic Value of Stock

Obviously, if you want to make a better investment decision, you'll need to know exactly how much your stock is worth. 

​So how do you value stock? - Let's take a look at the 6-step process below.

To find intrinsic value of a stock, you can follow the steps listed below:

  1. ​Find all required financial data
  2. Calculate discount rate and use it to discount the future value of the business
  3. Perform a discounted free cash flow (DCF) analysis
  4. Calculate the company's net present value (NPV)
  5. Calculate the company's terminal value (TV)
  6. Put the net present value and the terminal value together
intrinsic-value-formula-optin

Now let's dive into each step and learn how to do all the math!

Intrinsic Value Formula

intrinsic-value-formula-infographic

Step 1: Find All Needed Financial Figures

Before performing the calculation, it's worth taking a small step to find all the necessary numbers, and then you just need to plug them into the formulas given above.

In general, there is a total of 14 financial figures that you'll need to find before perfoming your cash flow analysis:

  1. Current Share Price: the price at which a company's stock is currently selling.
  2. Shares Outstanding: the total number of shares that are issued and currently owned by the company's shareholders.
  3. Free Cash Flow: this figure represents the company's capacity for generating free cash, which is used for its future expansion, paying off debts and enhancing its shareholder value.
  4. Long-term Growth Rate: the expected rate at which the company will grow.
  5. Business Tax Rate: the business income tax paid to the government. This tax rate varies among different countries.
  6. Business Interest Rate: the effective rate that the company is charged on its loans and borrowings.
  7. Perpetuity Growth Rate: often known as "terminal growth rate" or "implied perpetuity growth rate". The rate that the company is expected to grow at after our cash flow projection period. We'll use the country's GDP growth rate as a Perpetuity Growth Rate.
  8. Market Value of Debt: the total dollar market value of a company's short-term and long-term debts.
  9. Market Value of Equity: often known as "market cap". The total dollar market value of a company's outstanding shares.
  10. Stock Beta: often known as "beta coefficient". Beta is a measure of how much the price of the company's stock tends to fluctuate.
  11. Risk Free Rate: the minimum rate of return that investors expect to earn from an investment without any risks. We’ll use a return of the 10-Year Government’s Bond as a Risk-Free Rate.
  12. Market Risk Premium: the rate of return over the Risk-Free Rate required by the investors. For calculating the discount rate, you can use the market risk premium data from NYU Stern School of Business or use our risk premium data here. We use a lower market risk premium.
  13. Total Business Debt: the total liabilities of the company.
  14. Total Business Cash: the total cash and cash equivalents of the company.

Step 2: Calculate Discount Rate (WACC)

In my opinion, the discount rate is the most crucial component of our discounted cash flow (DCF) analysis.

If you frequently perform stock valuation, you would realize that we cannot use the same discount rate for every single stock.

The key mistake that many investors make is that they use a random discount rate, says 5%, 6%, or 7%, to compute the discounted cash flows of their stock.

After several years of being an independent investor, my experience tells me that every single stock will come up with a different discount rate.

Here are some real-world examples (I selected a number of random stocks):

#

Ticker Symbol

Business Name

Estimated Discount Rate

1

AAPL

Apple Inc.

8.69%

2

AMZN

Amazon.com, Inc.

10.65%

3

MCD

McDonald's Corp.

5.05%

4

NKE

NIKE, Inc.

4.56%

5

GOOGL

Alphabet Inc. (Google)

6.68%

6

PZZA

Papa John's International Inc.

6.46%

7

CGNX

Cognex Corporation

9.74%

8

GEL

Genesis Energy LP

8.36%

9

DIS

The Walt Disney Company

9.64%

10

TXRH

Texas Roadhouse, Inc.

4.87%

Now let me recall all the formulas that we use to calculate the Discount Rate.

Firstly, we'll need to calculate the After-tax Cost of Debt as follows:

cost of debt formula

Then, we'll use the Capital Asset Pricing Model (CAPM) to calculate the company's Cost of Equity. The CAPM formula looks like this:

cost of equity formula

And finally, we'll calculate the Weighted Average Cost of Capital (WACC) and use this rate as a discount rate:

discount rate formula

​As you can see, we need to take several steps to come up with the Discount Rate. There are 4 essential elements presented in our formulas:

  • After-tax Cost of Debt
  • Cost of Equity
  • Market Value of Debt
  • Market Value of Equity

So, if you use the same Discount Rate for every stock you value, you will have to assume that all of your stocks have the same Cost of Debt and Equity, and the same Market Value of Debt and Equity. And you know, that just doesn't happen!

Step 3: Calculate Discounted Free Cash Flows (DCF)

After having the discount rate, we'll use it to perform the discounted cash flow analysis. There are 3 steps that you'll need to follow:

  • Step 1: Project the Future Free Cash Flow (FFCF) of your stock
  • Step 2: Calculate the Discount Factor (DF)
  • Step 3: Calculate the Discounted Free Cash Flow (DFCF) of your stock
discounted cash flow dcf formula

Now let's take a look at this example:

Assume that the company in which you are looking to invest, has a trailing-twelve-month free cash flow of $100 million and is expected to grow by 10% every year. We'll use a discount rate of 6%.

Firstly, we use the long-term growth rate of 10% to project the future free cash flow of the company in the next 10 years. We assume that the business will consistently grow by 10% every year.

discounted cash flow (dcf) example - step 1

Next, we use the discount rate to calculate the discount factors, as follows:

discounted cash flow (dcf) example - step 2

The final step is to discount the future cash flows to arrive at the present value of each individual year's cash flow. We simply take the projected cash flow and multiply it by the discount factor, like this:

discounted cash flow (dcf) example - step 3

Step 4: Calculate Net Present Value (NPV)

Once we have all the discounted free cash flows of the business, we can now calculate the Net Present Value using the NPV formula:

net present value (npv) formula

In our example, to come up with the present value, we simply sum all the discounted cash flows together:

calculating present value

The result represents the total present value of the company's future cash flows. It's worth noting that this value is NOT the firm's intrinsic value yet.

Some investors make a serious mistake that they treat the net present value as their stock's intrinsic value. Actually I made the same mistake when I first started out, and this mistake taught me a valuable lesson.

If you use the present value of a company's future cash flows as its intrinsic value, you are basically saying that that company will stop operating at the end of your projection period.

That is simply not true.​

Chances are the business will continue to operate after 10 years (unless it goes bankrupt due to some unexpected financial issues).

And that's why we need to take one further step to calculate the perpetuity value of the business.​

Step 5: Calculate Perpetuity Value (Terminal Value)

The perpetuity value, or terminal value, is simply the total present value of a company's future free cash flows beyond our forecast period.

This value will then be discounted back to the end of the projection period (year 10) at the discount rate, or the weighted average cost of capital (WACC).

The complete formula for calculating terminal value looks like this:

terminal value formula

We will not use the firm's long-term growth rate to estimate its terminal value. We'll use another growth rate, which is called "perpetuity growth rate".

Why?

The reason is simple - the expected long-term growth rate is normally higher than the economy's growth rate. 

Logically, a business cannot grow faster than the economy forever.

So, if you use a growth rate that exceeds the GDP growth rate, you will have to assume that your stock will be able to outpace the economy forever. 

For valuation purposes, we'll use the GDP growth rate as a terminal growth rate, where we assume that our stock will grow at the same pace as the economy after our forecast period.

Now let's take a look at this example. Assume that we have:

  • GDP Growth Rate (Perpetuity Growth Rate) = 3%
  • Year-10 Projected FCF = $259.37 million
  • Discount Rate (WACC) = 6%
  • Year-10 Discount Factor = 0.558

Plugging these figures into the above formula, we can now calculate the business terminal value, like so:

example terminal value calculation

Step 6: Sum The NPV and Terminal Value

After calculating the present value and the terminal value, we simply put these values together so that we can come up with the company's intrinsic value.

Next, we'll adjust the calculated value by adding the business net cash, and then divide the result by the total number of shares outstanding.

You can easily calculate the company's net cash by subtracting its total liabilities from its total cash and cash equivalents ("less debt, plus cash").

The complete formula looks like this:

intrinsic value formula

Now let's calculate the true value of the stock in our example.

Assume that the company's stock is currently selling at $12.56 a share, with 400 million shares outstanding. It has $100-million cash on hand, and a total debt of $250 million.

  • Net Present Value = $1232.91 million
  • Discounted Terminal Value = $4969.01
  • Total Cash & Cash Equivalents = $100 million
  • Total Liabilities = $250 million
  • Shares Outstanding = 400 million
  • Current Share Price = $12.56

Plugging these figures into the given formula, we'll arrive at a real value per share of $15.13:

example intrinsic value per share

Knowing how to calculate intrinsic value isn't enough. You'll need to analyze the result and then determine whether this stock is undervalued or overvalued.

For this purpose, we'll compare the value per share with the current share price.

intrinsic value analysis

As you can see that the stock in our example is currently selling at $12.56 a share, while its real value per share is greater than $15.13. So, this stock is undervalued.

Read also: How to Find Undervalued Stocks Using PEGY Ratio​

How to Find Intrinsic Value Example

Now let's consider a quick example, so that you can understand clearly how to perform a DCF analysis of a stock in which you want to invest.

Intrinsic Value Example - Company ABC

Company ABC's stock is currently selling at $58.41 a share. It has 43.14 million shares outstanding with over $2.52 billion in market capitalization. Financial analysts predict that this company will potentially grow by 8% annually.

Looking into the company's financial statements, we find that this company has:

  • Free Cash Flow = $112.50 million
  • Cash & Cash Equivalents = $16 million
  • Market Value of Debt = $246.25 million
  • Total Liabilities = $348 million

Other data:

  • ​Beta coefficient = 1.24
  • Business Income Tax Rate = 30.00%
  • Interest Rate = 2.00%
  • Risk Free Rate = 1.76%
  • Market Risk Premium = 5.50%
  • Perpetuity Growth Rate = 2.40%

Requirements: 

  • Find intrinsic value of this company's stock
  • Determine whether this company's undervalued or overvalued

How to Find WACC (Discount Rate)

First of all, we'll calculate the weighted average cost of capital (WACC) of this company, and then use this rate as a discount rate.

What we need:

  • Interest Rate = 2.00%
  • Business Tax Rate = 30.00%
  • Stock Beta = 1.24
  • Risk Free Rate = 1.76%
  • Market Risk Premium = 5.50%
  • Market Value of Equity = $2,520 million
  • Market Value of Debt = $246.25 million
  • Total Market Value of Debt & Equity = $2766.25 million

Calculations:

Calculate After-tax Cost of Debt (Rd):

example 1 cost of debt

Calculate Weight of Debt (Wd):

example 1 weight of debt

Calculate Cost of Equity (Re):

example 1 cost of equity

Calculate Weight of Equity (We):

example 1 weight of equity

Calculate Weighted Average Cost of Capital (WACC):

example 1 discount rate (wacc)

How to Find Discounted Free Cash Flows (DFCF)

​Our next step is projecting the future free cash flows of this business.

We'll use the long-term growth rate to forecast the future free cash flows of this company in the next 10 years, and then discount each year's cash flow to the present.

What we need:

  • Long-term Growth Rate = 8.00%
  • Free Cash Flow = $112.50 million
  • Discount Rate = 7.94%

Calculations:

Calculate Projected Free Cash Flows (PFCF):

example 1 calculate projected free cash flows (pfcf)

Calculate Discount Factors (DF):

example 1 calculate discount factors (df)

Calculate Discounted Free Cash Flows (DFCF):

example 1 calculate discounted free cash flows (dfcf)

How to Find Net Present Value (NPV)

To calculate the Net Present Value of Company ABC, we simply sum all the discounted free cash flows together, like this:

example 1 calculate net present value (npv)

How to Find Terminal Value (Perpetuity Value)

Our next step is calculating the company's terminal value.

What we need:

  • Perpetuity Growth Rate = 2.40%
  • Discount Rate = 7.94%
  • Year-10 Projected Free Cash Flow = $242.88 million
  • Year-10 Discount Factor = 0.466

Calculation:

example 1 calculate terminal value

How To Calculate The Value Of A Company

Finally, you can follow the steps below to calculate this firm's intrinsic value:

  • Add the Net Present Value and the Terminal Value together
  • Adjust the result by adding the company's net cash ("Plus cash, minus debt")
  • Divide the adjusted value by the total number of shares outstanding

Calculation:

example 1 calculate intrinsic value

Company ABC's stock is currently selling at $58.41 a share, while its true value per share is $66.95. The result tells us that this company is currently undervalued.

Intrinsic Value Calculator

I have to admit that performing stock valuation is extremely time-consuming and that really does require a lot of work and patience.

When I first started investing in stocks, I sucked big time at this valuation process, because it took me many steps just to get the real value of a single stock.

You know, there are thousands of companies out there listed on the stock market. To find a good investment, you will have to evaluate many of those companies.

Trust me... being a value investor isn't easy at all, especially when you have to do everything manually.

That's why I'm a big fan of automation. I try to automate everything I can to save time and get better results. And that's why I decided to automate my entire valuation process.

My team and I developed an Intrinsic Value Calculator, a simple tool that can save us loads of time and energy.

Now let me show you how this amazing tool works...

Using the calculator is very simple - you just need to add some required information regarding your stock into the calculator, and it will get everything done for you.

example-abc-intrinsic-value-calculator

As you can see, we instantly get the real value per share of $66.92, and the tool automatically helped us determine that the stock is currently undervalued.

And that's it - everything is done for you!

The Bottom Line

​There you have it - a detailed guide on how to determine if your stock is currently undervalue or overvalued.

The only problem with value investing is that it requires a large amount of work devoted to analyzing and evaluating potential companies.

But nothing that's profitable is ever easy, right?... So try to practice what you've learned by using a FREE paper trading account, put in the work, and then be proud of being a passionate value investor 😀

I love using the DCF analysis along with other investment criteria. What is your favorite valuation method/investing metric?

Feel free to share your thoughts in the comment's section below. 

intrinsic-value-case-study-optin
Hung Nguyen
 

Entrepreneur, independent investor, instructor and a visionary of my team here. I've been playing with stocks and sharing my knowledge to the world. The stock market is cool, and I love it!

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