Intrinsic Value

Intrinsic value in a corporation can be difficult to determine. Intrinsic value is calculated by a set of qualitative and quantitative analysis studies that may differ depending on the calculator. Some investors have their own method of determining intrinsic value. Warren Buffett is a good example of this investor class. Regardless of the method used to evaluate a company's intrinsic value, it is clear that it is not always the market share price.

In a fundamental analysis, value investors use factors such as business model, management style and target markets to make investment decisions based on qualitative measures. Quantitative analysis involves financial reports and more discreet numbers assessment. A company's positioning in emerging markets is always a good indicator for investors who are looking for a company that is under-valued at its market price with a good financial forecast.

Understanding intrinsic value in any company or asset requires an understanding of put options and call options. A put option is the calculation between the asset's strike price and the underlying stock's price. A call option is the calculation between the underlying stock's price and the strike price. The result is that the intrinsic value can never be negative because it results in a value of zero. An option is never worth less than what the holder can receive when exercised.

Companies also have extrinsic values as well, which is effectively the opposite of intrinsic. Extrinsic value is expressed as the difference between the stock's premium price and the intrinsic value. It is not as qualitative in assessment. The extrinsic value decreases as the option moves to expiration. The primary characteristic of both call and put options is that they are basically a bet. There is significant risk involved in options trading and should only be done with risk capital.

Professional traders such as Warren Buffet normally use their own calculation formula. Buffet, in particular, begins with the earnings per share for the previous year and determines the growth assumption of the stock over the next five years. This provides an annual growth rate. He then assesses market confidence across that period according to goal and forecast. The question is the likelihood of the stock hitting the forecast mark. This results in a general intrinsic value. Then the result is compared to the margin of a U.S. Treasury yield.

Of course as Buffet and others found out, value is only what the market is willing to pay for a given object at a given time. During the initial economic crisis in 2007, the economy came close to melting down. If the US government hadn't printed and injected trillions into the larger marketplace, the carefully calculated values created by Buffet and others would have proven useless. Thus, such value predictions are at least partially artificial and dependent on larger economic variables for which Buffet had not anticipated.