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What is an Intrinsic Value Formula?
The formula for Intrinsic value basically represents the net present value of all the future free cash flows to equity (FCFE) of a company during the entire course of its existence. It is the reflection of the actual worth of the business underlying the stock i.e. the amount of money that can be received if the whole business and all of its assets are sold off today.
Intrinsic value Formula
Intrinsic value formula for business and stock is represented as follows –
#1 – Intrinsic Value Formula of a Business
Mathematically, the intrinsic value formula of a business can be represented as,
- where FCFEi = Free cash flow to equity in the ith year
- FCFEi = Net income i + Depreciation & Amortisation i – Increase in Working Capital i – Increase in Capital Expenditure i – Debt Repayment on existing debt i + Fresh Debt raised i
- r = Discount rate
- n = Last projected year
#2 – Intrinsic Value Formula of a Stock
The calculation of intrinsic value formula of stock is done by dividing the value of the business by the number of outstanding shares of the company in the market. The value of stock derived in this way is then compared with the market price of the stock to check if the stock is trading above / at par / below its intrinsic value.
Intrinsic Value Formula Stock = Intrinsic Value Business / No. of outstanding shares
Explanation of the Intrinsic Value Formula
The calculation of formula of the intrinsic value of a stock can be done by using the following steps:
Step 1: Firstly, determine the future FCFE for all the projected years based on the available financial plan. The projected FCFEs can be computed by taking the latest FCFE and multiply it with the expected growth rate.
Step 2: Now, the discount rate is determined based on the current market return from an investment with similar risk profile. The discount rate is denoted by r.
Step 3: Now, calculate the PV of all the FCF by discounting them using the discount rate.
Step 4: Now, add up the PV of all the FCF calculated in step 3.
Step 5: Next, the terminal value is computed by multiplying the FCFE of the last projected year by a factor in the range of 10 to 20 (can use reciprocal of the required rate of return). The terminal value represents the value of the business beyond the projected period until the business is shut down.
Terminal value = FCFE n * Factor
Step 6: Now, to arrive at the value for the entire business, add up the value of step 4 and the discounted value of step 5 along with any cash & cash equivalents (if available).
Step 7: Finally, the intrinsic value per share can be derived by dividing the value in step 6 by the number of shares outstanding of the company.
Example of Intrinsic Value Formula (with Excel Template)
Let us take an example of a company XYZ Limited which is currently trading in the stock market at $40 per share with 60 million shares outstanding. An analyst intends to predict the intrinsic value of the stock based on the available market information. The prevailing required rate of return expected by the investors in the market is 5%. On the other hand, the free cash flow of the company is expected to grow at 8%.
The following financial estimates are available for CY19 based on which the projections have to be made:
So, from the above-given data, we will first calculate the FCFE for CY19.
FCFE CY19 (in millions) = Net income + Depreciation & Amortisation – Increase in Working Capital – Increase in Capital Expenditure – Debt Repayment on existing debt + Fresh Debt raised
- FCFE CY19 (in millions) = $200.00 + $15.00 – $20.00 – $150.00 – $50.00 + $100.00
- = $95.00
Now, using this FCFE of CY19 and FCFE growth rate we will calculate the Projected FCFE for CY20 TO CY23.
Projected FCFE of CY20
- Projected FCFE CY20 = $95.00 Mn * (1 + 8%) = $102.60 Mn
Projected FCFE of CY21
- Projected FCFE CY21 = $95.00 Mn * (1 + 8%)2 = $110.81 Mn
Projected FCFE of CY22
- Projected FCFE CY22 = $95.00 Mn * (1 + 8%)3 = $119.67 Mn
Projected FCFE of CY23
- Projected FCFE CY23 = $95.00 Mn * (1 + 8%)4 = $129.25 Mn
Now we will calculate the Terminal value.
Therefore, the calculation of Intrinsic value for the company will be as follows –
Calculation of Intrinsic Value for the Company
- Value of the company = $2,504.34 Mn
After this, we will do the calculation of Intrinsic value per share which is as follows –
Calculation of Intrinsic value per share
- Intrinsic value formula = Value of the company / No. of outstanding shares
- = $2,504.34 Mn / 60 Mn
- = $41.74
Therefore, the stock is trading below its fair value and as such, it is advisable to purchase the stock at present as it is likely to increase in the future to attain the fair value.
Relevance and Use of Intrinsic Value Formula
The value investors build wealth by purchasing fundamentally strong stocks at a price way below their fair value. The idea behind the formula of intrinsic value is that in the short term the market usually delivers irrational prices, but in the long run, the market correction will happen such that the stock price on an average will return to the fair value.
This has been a guide to what is Intrinsic Value Formula. Here we discuss how to calculate Intrinsic Value of Business and Stock using practical example along with downloadable excel templates. You may learn more about Valuations from the following articles –