What is the Right Price of a Stock? How do you Asses its Intrinsic Value?

Before investing in a stock, you need to know if it’s available at the right price: a price that reflects its Intrinsic Value. Intrinsic value essentially means a value based on things the company has that generates value (read profits, cash flows or replacement cost of all its value-generating assets) and not on  external things. This is quite difficult to assess very accurately; there can only be estimates. There are different methods to estimate Intrinsic Value that work in different situations. Since we are assessing a listed company, i.e. an established company and not a start-up, the most relevant method is the Discounted Cash Flow, or simply the DCF method.

If you were to buy the whole company, what price should you rationally pay for it?

You would look at the cash it would be able to give you every year, and add it up. But you can’t simply add up cash generated in different years, because Rs. 100 today is not the same as Rs. 100 one, two or three years later. So, you have to reduce the value of the cash generated in the future years by a factor, to make it equivalent to its value today or its Present Value. This is the money you earn while you own the company. And suppose you decide to sell it after a fairly long time, you would get some money for it based on what is called the Terminal Value. All this depends on the company’s ability to generate cash flows or simply profits, and hence, its intrinsic value too.  Now, as a Retail Investor, you own some shares in a company, but you can apply the same principle as above to arrive at the Fair Value of the stock. It is a bit different from its Intrinsic Value, but we can approach it in a rational manner. We, at MoneyWorks4me, prefer to call this the MRP or Maximum Retail Price of a stock.

The Fair Value of a stock relates to the returns that investors expect to receive from holding the stock. So, to arrive at the right value of a stock, you need to look at the future returns you will get by investing in a stock, and then discount them to arrive at its Present Value using an appropriate rate of...........Read More

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