The Only Intrinsic Value Guide You Need | Mastering Value Investing Pt. 2:

In last weeks article, we talked all about my personal favorite type of investing (and Warren Buffett's): value investing. All about finding the stocks that are extremely healthy, just on a discount at the moment. To learn about the metrics we went over, read our last issue here. I teased at the end that, unfortunately, intrinsic value is a more difficult metric, as you have to solve for it by hand. But why would you even need intrinsic value, let alone solve for it? Let's dive in.

Why This Article is Necessary (and long)

Simply put, the intrinsic value is the true worth of an asset. Whether it's a stock, ETF, painting, gold, or a home-made knick-knack. However, with stocks it's more then common for the stock price to be over inflated what the stock is actually worth. Calculating this could help you beat the population to discovering a bubble. For those who don't know: a bubble is where a stock price is driven far above it's actual value through speculation and FOMO, often followed with the sharp decline once this facade is found out, called the 'bubble pop'. So while it may seem silly finding the intrinsic value of stocks, since most are trading above their true worth, it helps you find the exception, and prevents you from making a potentially detrimental mistake. More importantly, Monk Investments is dedicating an entire article to it, therefore it must be important.

Step One: Research

As promised, let's break down in plain English how intrinsic value can be calculated. A quick reminder: you don't have to crunch or find these numbers yourself, feel free to use an AI tool or an intrinsic value calculator; but you will need to setup the equation for both. Some info you will need to find beforehand:

• Future Cash Flows - A forecast of the company's expected annual free cash flow for the next 5-10 years ideally. You can also use financial reports if you feel so brave.

• Select The ROI - Pick the ideal return you'd require for this particular stock in years. (Typically 8-12%, can be higher)

• Estimate Terminal Growth Rate - The rate you expect cash flow to grow indefinitely after your projection year (a year in our case) P.S - This doesn't have to be an extremely accurate guess, when in doubt use 1-3%.

Step Two: Present Value

After writing all of these out, or having the tabs of the desired info, you can finally get to the actual solving. We will use the equation PVt=CFt/(1+r)^t, which looks a lot more scary than it really is. Here's what each value is defined as:

• PVt - Present Value (half-way to finding intrinsic value!)

• CFt - Cash flow in year(s), t

• r - Discount rate (your ROI you picked in a decimal format)

• t - Year number (1,2,3, ...)

For example, if I were calculating the present value of a year where I expected 'company A' to have $10 million in free cash flow for year 1, $12m year 2, and so on ending year 5 with $18m. My equation would look like this: 10/(1+0.10)^1 =9.09. Again, for a more accurate intrinsic value though, you may want repeat this equation for 5-10 years.

Step Three: Terminal Value

Now that the hard part is done, we just have to estimate the terminal value using another scary but harmless equation: Terminal Value=CFn×(1+g)/r-g. Let's go over the terms in this equation real quick:

• CFn - Cash flow in the final projected year ($18m for Company A)

• g - Terminal or perpetual growth rate (2% for Company A)

• r - Discount Rate (10% for Company A)

So if we continued our example, our equation would be (18x1.02)/(0.10-0.02)=229.50 million.

Step Four: Intrinsic Value!

But this is the future Terminal Value, we need the present. So we will divide the 229.50 we got by the present year: 229.50/(1+0.10)^5=142.60 million. Now that we have the present terminal value, we simply add it with the sum of all projected cash flows ($51.63m for company A, years 1-5): 51.63+142.60=194.23 million.

Optional Step: Value Per Share

Ta-Da! You did it! This value can be compared to the company's current market cap, or you can optionally divide it by how many shares outstanding to find what the value per share is. Company A - 194.23/10= $19.423 per share.

Please put this equation into practice for the next stock you think about buying. I know this process is long and looks difficult, but with some help from AI and practice, you can cut through the news about a stock and get straight to the core; something we all need in this news saturated market we live in. Please subscribe if you've enjoyed this article and want to see more like it. (it's free)