A grand beach view apartment is yours, and you wish to show it to your friends and relatives. From the many opinions and thoughts, one comment you would receive will be, "I think you paid more than its actual price." From vegetables to big capital assets, we expect to get everything at a fair price. Sometimes lesser than the fair price. And the share market is not free from such expectations.
Acquiring assets at their intrinsic value is also termed as value investing. This is the most rewarding way of investing as per the view of many top investors. Before learning the method of finding out the intrinsic value of shares, it is essential that you know what the term itself means.
Intrinsic value of Share
Say you are buying gold. Now you won't blindly pay anything, right? You will find out what the fair value is and then pay the price similarly in the stock market, paying the right, sometimes less than the right one, is important. That is where intrinsic value comes into play.
Intrinsic value is the real value of the asset or the business. Investors try to acquire the stock below or at this value in order to receive a good return on investment. However, finding out the intrinsic value of a share is not an easy task. A few methods which analysts use in order to land at the intrinsic value are as follows:
- Discounted cash flow analysis.
- Financial metric and technical metric based analysis.
- Asset valuation.
- Earnings growth model.
In this blog, you will be walked across the steps in evaluating the discounted cash flow analysis with which you can land on the intrinsic value of a share.
Discounted cash flow analysis
Another beneficial method that assists you in arriving at the intrinsic value is DCF analysis. Discounted cash flow analysis uses the free cash flow to determine the current value or the intrinsic value of the asset. It tells the investor whether the investment he is making today would give him the anticipated return in the future. This method is widely used by companies, financial analysts, and investors like you and me to find the actual value of any investment. So are you baffled as to whether to buy a stock or not? Then, quickly run a DCF analysis.
The entire DCF or discounted cash flow analysis uses the time value of cash, which is basically built upon the assumption that 'a rupee today is better than a rupee tomorrow.' This is because the rupee you have in your hand can be invested, and its value can be subsequently increased.
You can use an excel sheet to calculate the DCF or simply use the formula,
Discounted cash flow - DCF = CF1/(1+r)1 + CF2/(1+r)2 + CFn/(1+r)n
CF = the cash flow of the n number of years and
r = the discount rate
DCF is also known as net present value. Say a businessman is planning to expand his business. He is planning on purchasing a plant. But he wants to know whether the investment he would like to make will be profitable in the future. In that case, he can take the help of the DCF analysis to land on a solution. If the project's cost is less than the calculated DCF, then the proposed investment will be a good one.
If it is above the DCF value, it is highly advisable to skip the deal placed on the table. In order to conduct a DCF, you will have to make proper estimates or assumptions about the various figures. You will need to know the future cash inflow of the investment or the company you are about to invest in. You will be required to find out an almost precise discount rate as well. When companies use DCF, they employ the WACC (Weighted Average Cost of debt and equity) in the place of the discount rate. This method can also be used to evaluate options, bonds, real estate, or any assets.
Apart from all the benefits derived from the model, it inevitably suffers a few limitations. They are pointed out as follows.
- As mentioned earlier, the DCF value depends upon the input values. Hence, any mistake from your side might land you in serious trouble.
- The cash flows and growth rate of a company used here are futuristic in nature. Thus, there is every possibility for the predicted figure to be inaccurate. For instance, if a company has to put up with an unexpected economic slowdown, then the estimated cash flow figure will go wrong.
- The complexity of the proposed project will also make the DCF calculation faulty.
How to calculate the intrinsic value of Share using Ticker?
Before we jump into the basis of calculating the amount using Ticker, it is essential we brush up a few basics. Let's find the meaning behind certain terms.
- Discount rate – this can be simply described as the rate of return which you will need.
- Terminal value – it is the value of the stock or asset that you purchased beyond the estimated time, say after 10 years.
Now we have come to the most crucial and interesting part. Who is going to take the calculator and have the patience to do it the old way? For all those who are looking for a simple and accurate alternative, then here you go. How to calculate the DCF value using Ticker? You can simply do that by following the steps mentioned below.
- Type the name of the stock you want to check upon.
- After which you can access the calculator by clicking on the 'ticker plus icon'.
- Now use both the earnings growth model and discounted cash flow model in order to land on a more accurate value.
Have you read our previous Master Class: What is Free Cash Flow? And how to calculate it?
Enter the values such as discount rate, CAGR in EPS, the margin of safety, etc. Once entering all the details required, click on the 'calculate' icon to find out the actual value you can purchase the stock at. In order to make your task hassle-free, you can use the figures that appear as 'hint' whenever you click a particular box. You can also use the valuation charts for the calculation of P/E. Say, on average; the company has made 30 throughout the 5 years time period, then you can take that value for calculation. However, it is highly suggested that you enter the number being a little on the conservative side. We guess we wrapped whatever we could. For further information, click: YouTube
All you have to do now is put the various stocks you want to purchase in an excel sheet. Along with them, put the ratios which you can easily extract using Ticker. Finally, calculate the discounted cash flow for them and find out the best stocks you can put your money into. When you are operating on data, you are more likely to succeed compared to betting on beliefs, luck, and some unknown tips. So when are you going to start?
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