How to Calculate Intrinsic Value

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Intrinsic value is not necessarily the fair market value of an item, investment, asset or business, but the sum of the value inherent in its parts. A car might be sold for $20,000, but that includes the profit margin ensured by the dealer. The car's intrinsic value might be only $18,500, even though it can be sold for a higher price. You can calculate intrinsic value in different ways depending on the item you are valuing.

Understand that, for many items, you'll need to use labor to calculate intrinsic value. For example, if it takes six hours for four people to manufacture a widget, and each laborer is paid $10 per hour, the labor intrinsic value of that widget would be 24 labor hours, six hours x four people, for a total of $240.

Realize that to calculate the intrinsic value of commercial real estate, you will need to factor in the future cash flow monies that will be lost or gained as the result of a sale. Property taxes, maintenance costs, monthly rent and other costs must all be used to arrive at an accurate number, in addition to the value of the property. The precise formula will depend on geographic location and current market conditions, and must be adjusted for inflation.

Calculate the intrinsic value of a stock by dividing the earnings per share on the stock you are considering by the annual earnings on another investment, such as bonds or real estate. For example, if the EPS on a stock is $2.40 and a bond will earn 4 percent interest annually, you would divide $2.40 by .04 percent for an intrinsic value of $60.

Understand that it is difficult to calculate the intrinsic value of a business or enterprise. The IV of a business is the sum of ongoing cash flow from daily operations, and can be calculated over any span of time, including perpetuity, depending on your purposes.

Calculate intrinsic value based on the sum of an item's parts. For example, when you manufacture a product, the IV can be the combined value of every screw, nail, bolt, clip and material used to assemble it. This is different from market value in that it doesn't include the seller's profit or the cost of labor.

Tips

  • Intrinsic value cannot be calculated for stocks and other assets if there are no positive earnings.

    When possible, buy a business at a price that is less than its calculated intrinsic value.

Warnings

  • Make sure that the EPS you use to calculate intrinsic value for stocks is as accurate as possible and based on several years of performance.

References

About the Author

Laura College is a former riding instructor, horse trainer and veterinary assistant. She has worked as a writer since 2004, producing articles and sales copy for corporations and nonprofits. College has also published articles in numerous publications, including "On the Bit," "Practical Horseman" and "American Quarter Horse Journal."

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