Value Investing – Principle #2: Intrinsic Value (Lesson 7)
Intrinsic value is just one of the four principles of value investing. Intrinsic value sets the floor price of the investment; i.e. it is an automatic buy. Any price higher than this intrinsic value must be substantiated by other value investing criteria. In effect, other criteria may increase the buy point upwards of 20%.
Intrinsic value utilizes one or more of three different valuation methods. The first method and customarily applicable to high quality stocks is the discounted future free cash flow formula. The second method works best with penny and small-cap stocks; this is the traditional book method. Mid-caps’ intrinsic value is best served by the net assets value method adjusted to fair market value of the underlying assets. Those companies with strong fixed asset positions in the mid-cap market capitalization range are best served by this particular method. In effect, the accuracy increases significantly with the net assets value adjusted by fair market values for the underlying fixed assets.
Value investors customarily use the discounted cash flows method; but here too, there are adjustments tied to certain criteria to provide a more accurate and reasonable intrinsic value for the stock.