Intrinsic Value Definition
The estimated value of tangible as well as intangible resources is known as the intrinsic value of a business or a company. These resources are determined with the help of basic research or analysis. This value is also known as the true value of an organization. Normally, the company estimates this value without taking reference of actual market value. It is not necessary that the market and the Intrinsic value of a company will always be equal.
A Little More on What is Intrinsic Value
The traders figure out the qualitative (target market, admin authority, business model) and quantitative (financial, other percentages and statement analysis) prospects of the business and then estimate the intrinsic value of the company. They use the comparison of estimated intrinsic value and the present market value to examine the company is depreciated or overvalued.
For the calculation of the intrinsic value of a company, the most common technique is the Discounted Cash Flow (DFC) model. Discounted Cash Flow is a process to estimate the investment opportunities in the future at the present time. It uses free cash flow of the organization and the weighted mean cost of equity. The purpose is to discount the overall expected cash flows of the future to the current value.
The investors use this method to find out the hidden investment possibilities. It requires a deep understanding of the basic analysis.
Intrinsic Value of Options
The intrinsic value of call options is calculated by taking the difference between the present stock price and the strike price of the option and then multiply it with total no. of shares that options can buy.
Put options of the intrinsic value, the case is just inverse. This is the difference of option’s strike and present stock price and then multiply it with the total shared that options can buy.
If in any case, the calculated value is negative, then give intrinsic value a zero value, i.e. the options will not include in money.
Extrinsic value includes all the external factors that can affect the price of the option (e.g. time value and implied volatility). The total value of the price of the option can be determined by combining both intrinsic and extrinsic values.
Intrinsic Value of Options Examples
Let’s suppose, If a stock has 40 USD for trading one share and you have 4 call options which allow you to purchase 100 shares at the price of 35 USD, the intrinsic value of the call options will be difference between the price of the stock and strike, that becomes $5, multiply this value with four hundred shares, you will get 2000 USD.
Now, suppose, a trader buys a put option that is priced at 15 USD for fifty cents when the stock traded at 16 USD. Subtract the strike and the stock price, i.e. 15 USD – 16 USD, is -ve; so, the intrinsic value becomes 0 USD. This is because the option has no more money. However, still the option is having a value that it gets from the extrinsic value, subtract the purchase and the intrinsic values, or 50 USD – 0 USD, you will get 50 cents/share.
References for Intrinsic Value
Academic Research on Intrinsic Value
- What is the Intrinsic Value of the Dow?, Lee, C. M., Myers, J., & Swaminathan, B. (1999). The Journal of Finance, 54(5), 1693-1741. This study has been carried out to develop a model of the time-series relationship between the intrinsic value and price in terms of a cointegrated system. The objective is to converge both the value and the price. For analyzing the performance of the model, a comparison is made for the Dow thirty stocks based on different estimates of the intrinsic value. At the time of 1963 to 1996, the prediction power of old market multiples (such as E/P, D/P, and B/P percentages) was less. However, according to statistics, a V/P ratio, where V depends on the residual income estimation model has good predictive power. More analysis depicts that analyst forecasts and rates of time changing interest play an important role in V’s success. Risk premia and substitute forecast perspectives are less influential.
- Intrinsic vs. extrinsic value, Zimmerman, M. J. (2002). Intrinsic vs. extrinsic value. This article elaborates a comparison to differentiate Intrinsic and extrinsic values in detail.
- The varieties of intrinsic value, O’Neill, J. (1992). The Monist, 75(2), 119-137. This paper provides an overview of the multiple types of intrinsic value.
- Intrinsic value, quantum theory, and environmental ethics, Callicott, J. B. (1985). Environmental ethics, 7(3), 257-275. This research describes an overview and analysis of Intrinsic value, environmental ethics and quantum theory.
- Currency returns, intrinsic value, and institutional‐investor flows, Froot, K. A., & Ramadorai, T. (2005). The Journal of Finance, 60(3), 1535-1566. In this study, the currency returns are decomposed into the shocks of expected return (transitory) and intrinsic value (long lasting). An analysis is performed to find out the interactions between these different shocks such as currency returns and organizational trading currency flows. Intrinsic value shocks dominated by shocks of expected return, irrelevant to flows (temporary shocks relates with flows), and positively linked with differentials of estimated accumulated interest. The results show that flows relate to short term (temporary) currency returns whereas fundamentals clarify the values and returns of long term in a better way. They also deliberate the longlasting bad performance of exchange rate models. If we ignore the difference of changes in the transitory and permanent exchange rate, earlier tests show a connection in currencies and the fundamentals.
- Existence value and intrinsic value, Attfield, R. (1998). Existence value and intrinsic value. Ecological Economics, 24(2-3), 163-168. This study explores how the concepts of existence and intrinsic value are related to ecological ethics. Different techniques which are used to calculate the existence value are considered, and the investigation is on whether these techniques are a reliable source of considering non-use value in decision-making practices. Specifically, the author does not agree with Jonathan Aldred, that not all the carriers of intrinsic value meet the criteria in which he defines existence value. Plausible counters are like the undiscovered and expected carriers of this value (Sec 2) He also finds the two suggested measures related to existence value difficult, i.e. willingness-to-pay and willingness-to-accept (Sec 3). Lastly, he ends the discussion (Sec 4) with, to support the decision making in the free market on the estimation of valuers, it does not succeed in giving a value. Rather a technique is required which directly considers and measures the interests of future humans and nonhuman bodies.
- Earnings, cash flows, and ex post intrinsic value of equity, Subramanyam, K. R., & Venkatachalam, M. (2007). The Accounting Review, 82(2), 457-481. This article addresses the importance of earnings, operating cash flow and the intrinsic value of capital for comparison.
- On the relation between ecosystem services, intrinsic value, existence value and economic valuation, Davidson, M. D. (2013). Ecological Economics, 95, 171-177. In this paper, the writer states that several economists have tried to join together the concepts of ecosystem services and intrinsic value, mostly with a temporary pause on the economic idea of existence value. A misunderstanding of ideas is the basis of these attempts. However, the author differentiates 2 categories of non-use values; a value which relates the contentment people get from altruism to nature is known as “warm glow value” while the existence value relates the contentment of people that is obtained just knowing that nature exists and initializing in the human necessity for self-surpassing. Being advantageous to humans, economists can consider existence and warm glow values as ecosystem services. Existence value, as well as warm glow value, do not exhibit advantages to nature itself. However, intrinsic value remains beyond the scope of ecosystem services’ broad palette. This research explores various attempts that economists have made for joining the intrinsic value and the ecosystem services’ theory.
- Intrinsic value of business-to-business relationships: An empirical taxonomy, Biggemann, S., & Buttle, F. (2012). Journal of Business Research, 65(8), 1132-1138. This paper is about the B2B (Business to Business) relationships. A thorough analysis has been made on the empirical taxonomy.
- The intrinsic value of obeying a law: Economic analysis of the internal viewpoint, Cooter, R. (2006). Fordham L. Rev., 75, 1275. Economic theory abruptly differentiates in what individual desires and what he can get. Preferences state what an individual desires and constraints state the limitations of what he can get. The conflict of constraints and preferences creates the options that economists go through. Both terms have broad and negotiable meaning. Constraints and preferences assist in making a difference in the external and internal outlooks that got popularity because of H.L.A Hart. The internal outlook is related to preferences in order to conduct legal duties. An individual, who gives preference to complying a law, wants to leave something to conduct his legal duty. Here, there is an intrinsic preference, not a tool for securing some other value. On the other hand, a man, who does not care about a legal duty considers a totally instrumental idea towards obedience. He obeys just when this act secures some other value. Which factor elaborates the preferences distribution in people for complying a law? The author’s answer has become popular from psychological and economic researches. Getting a solution is important. This is because when the law is appropriately just and several citizens give intrinsic preference to comply with them, there is easier government and life improves when a majority of citizens do not care about complying a law.
- Measuring intrinsic value–how to stop worrying and love economics, Bakhshi, H., Freeman, A., & Hitchen, G. (2009). This research covers the scope of prevailing misunderstandings in the economists and funders, arts policymakers and leaders. In the United Kingdom, these confusions have a long debate on arts funding. These are quite obvious in the time taking discussions about intrinsic and instrumental concepts.to public expenses on arts and the culture. Being a public selected common theory, there are instruments used in economics for measuring the instrumental and intrinsic art values. They adopt such a method which can be measured with a common standard. This hesitance to use strong economic ways has been a hurdle instead of help for the art cases. This research presents a stimulating afterthought of the old and badly informed bias that stays behind this hesitation.
- The Theory of the Stock Intrinsic Value and the Bubble of China’s Stock Market [J], Huangsong, L. (2005). Economic Research Journal, 2, 45-52. This paper explains the Stock Intrinsic Value Theory and the stock market of China’s bubble.
- Price‐Earnings and Price‐to‐Book Anomalies: Tests of an Intrinsic Value Explanation, Fairfield, P. M., & Harris, T. S. (1993). Contemporary Accounting Research, 9(2), 590-611. Price variations from the fundamental valuation models depend on financial income and book value of proprietor’s capital. The owners use them to evaluate the intrinsic value detail of the anomalies of price-income and book value. The businessmen use comparative price variations from the involving benchmark prices in order to allocate years into the variation-groups having ups and downs. They design the traditional 0 investment technique of risk elimination (hedge portfolios) every year and compare the returns across variation years of ups and downs. The variation years of the ups depict fairly large size and risk accommodating returns over 4 holding periods, giving effective evidence that is favourable for the intrinsic value detail of anomalies. The results also show that the evaluation periods selected for earlier researches can have a vital role in the generated outcomes.