What is Intrinsic Value?

The intrinsic value meaning in share markets is understood as inherent value. That is correct. That is the intrinsic value meaning. The only question is how do you arrive at this inherent value or intrinsic value that you are referring to. Every asset has an intrinsic value due to some value inherent in it. Gold is valuable because it is difficult to mine and it is scarce. Similarly, equities have an intrinsic value because the company generates cash flows through its business. That is the basis. Let us look at what is the intrinsic value of the stock of a stock?

About Intrinsic Value

To answer the question of what is the intrinsic value of a share, you must first remember a basic rule. Intrinsic value is a measure of what an asset is worth. How do you decide how much the stock of a company is worth. Let us say you are an investor in stock and want to know what is the intrinsic value of the stock. The first thing you want to know is how much returns the stock will give. Now stocks give you returns in the form of dividends and capital gains.

As an investor, you can project dividends for profit-making companies. But, how do you project capital appreciation? That is tough. Instead, you project how much cash flows the business will generate over the years and then discount it back to the present value. That will give you a rough estimate of the intrinsic value of the stock. Of course, you further refine this intrinsic value by factoring in market P/E ratios, management quality, corporate governance standards, entry barriers, brand value, etc. The total of all these factors will give you the intrinsic value of the stock.

Remember, bonds have an intrinsic value, options also have an intrinsic value but here we will focus on the intrinsic value of equity shares. As a shareholder, you are the part-owner of the company so you do own a share of the cash flows, indirectly if not directly. The intrinsic value of the stock today will be decided by what is the cash flows the business can generate over the next few years and what is the growth it can deliver. So, all your intrinsic value calculations and estimates begin with projecting the future cash flows of the company.

There is no universal standard model for calculating the intrinsic value of a company and it is largely based on your perception, analysis, and judgment. Cash flows are based on your understanding of the business and your ability to extrapolate how the cash flows will look in the future. The calculation of intrinsic value begins with the quantitative model which is the discounted cash flow model or DCF model. This model calculates intrinsic value by projecting cash flows and discounting these flows to today.

The DCF model first estimates the future cash flows. You start with the future profits based on growth and then add back the non-cash items like depreciation and deduct average routine capital expenditure. That will give you net cash flows for the next few years. Normally intrinsic value concept uses the DCF model to value cash flows for the next five years and then uses the dividend discount model to estimate the value of the company at the end of five years. Then all these are discounted to the present using the weighted average cost of capital (WACC) to arrive at quantitative intrinsic value.

That is not the end. The quantitative intrinsic value is normally ratified with other parameters like market P/E, market P/BV, industry factors, management quality, corporate governance standards, etc. Once these qualitative factors are also considered, you finally arrive at a consolidated intrinsic value for the company which acts as your guide.

That is not the end. The quantitative intrinsic value is normally ratified with other parameters like market P/E, market P/BV, industry factors, management quality, corporate governance standards, etc. Once these qualitative factors are also considered, you finally arrive at a consolidated intrinsic value for the company which acts as your guide.

How gains from intraday trading are taxed?

When you buy and sell delivery shares from your Demat account, your gains are taxed as long-term capital gains or short-term capital gains tax. If a stock is sold after 1 year of purchase, it is LTCG, else it is STCG. However, the taxation of intraday trading is slightly different. Since intraday does not result in delivery, it is classified as speculative business income. The intraday trader has to maintain books of accounts and show this income from intraday trading as speculative business income.

There are 2 things to know. Speculative business losses can only be set off against speculative business income. They cannot be set off against normal business income or even against other capital gains. Secondly, while capital losses can be carried forward up to 8 assessment years, the speculative losses can only be carried forward for 4 assessment years for loss set-off purposes.

How to calculate intrinsic value?

Remember these 3 steps for calculating the intrinsic value of a stock

1. Project the cash flows for the next five years and then discount these cash flows to the present using WACC.

2. Calculate the value of the stock at the end of 5 years using the dividend discount model and also discount that value to the present.

3. The sum of the above will give you quantitative intrinsic value. That must be embellished with non-financial qualitative factors to get a proper estimate of intrinsic value.