Intrinsic value is what a stock is actually worth based on the cash the business will generate, as opposed to the price the market happens to be quoting. It is estimated with methods such as discounted cash flow, which adds up future cash flows after discounting them to today. If the intrinsic value is well above the market price, the stock is undervalued. The gap between the two is the margin of safety.
Intrinsic value is an estimate of a company's true worth, worked out from its fundamentals rather than its share price. Price is what the market is asking today. Value is what the business will return to its owners over its life. The two drift apart all the time, and the whole of value investing rests on spotting when the gap is wide enough to act on. Benjamin Graham built the idea, and Warren Buffett made it famous.
Why it matters
A share price can be driven by news, momentum, index flows and the mood of the day. None of that changes what the company earns. An investor with an estimate of intrinsic value has a reference point. When the price falls well below it, the stock is worth buying. When the price runs far above it, the stock is worth selling, however good the story. Without that reference point every decision is a guess about what other people will pay.
Discounted cash flow
The main method is discounted cash flow, or DCF. The idea is that a rupee next year is worth less than a rupee today, so future cash flows have to be shrunk, or discounted, before they are added up. The steps are to forecast the company's free cash flow for five to ten years, discount each year's cash flow at a rate that reflects the risk, add a terminal value for everything beyond the forecast period, and divide the total by the number of shares.
A short example. A company generates Rs 100 crore of free cash flow and is expected to grow it 10% a year for five years. The discount rate is 12% and growth after year five is assumed at 4% forever. The five forecast years are worth about Rs 474 crore in today's money. The terminal value, discounted back, adds about Rs 1,188 crore. The total is roughly Rs 1,662 crore. With 10 crore shares, intrinsic value comes to about Rs 166 a share. If the stock trades at Rs 120, it looks undervalued. At Rs 220, it looks expensive.
The answer is extremely sensitive to the inputs. Move the discount rate from 12% to 10%, or the terminal growth from 4% to 5%, and the value jumps. That is why analysts quote a range, not a single number, and why a worked walkthrough such as how to calculate the intrinsic value of a stock is worth reading before trusting any one figure.
Other methods
The dividend discount model values a share as the sum of its future dividends, discounted. It suits steady payers such as utilities and some blue chips. The Graham number is a quick formula: the square root of 22.5 times earnings per share times book value per share. For a stock with EPS of Rs 20 and book value of Rs 150 a share, that gives about Rs 260. Relative methods such as comparable company analysis use the P/E ratio and other multiples of similar companies. They are faster but only say whether a stock is cheap against its peers, not whether it is cheap in absolute terms.
Margin of safety
Because every estimate is uncertain, value investors only buy when the price is well below their estimate, typically by 25% to 40%. That buffer is the margin of safety. It covers mistakes in the forecast, bad luck in the business, and the time it takes for the market to agree. The bigger the uncertainty about the company, the bigger the margin should be.
What intrinsic value is not
It is not a precise number, and anyone quoting one to the rupee is overstating what the method can do. It is not useful for every company. A loss-making startup or a cyclical commodity producer has cash flows too unpredictable to discount with confidence. And it does not say when the market will close the gap. A stock can stay undervalued for years. For traders working in days or weeks, intrinsic value is background, not a signal. For anyone holding equity for the long term, it is the foundation.
FAQs
What discount rate should be used?
Usually the company's cost of capital, which for a large Indian company is around 10% to 13%. Riskier businesses get a higher rate.
Is intrinsic value the same as book value?
No. Book value is accounting net worth from the balance sheet. Intrinsic value is based on future cash flows and is usually much higher for a good business.
Where can free cash flow be found?
From the cash flow statement in the annual report. Free cash flow is cash from operations minus capital expenditure.
Can intrinsic value be calculated for the Nifty 50?
Yes, analysts do it by aggregating earnings and applying a long-run growth and discount rate. It is one way to judge whether the whole market is expensive.