Intrinsic value

Intrinsic value is the value an investor calculates from a company's fundamentals, independent of what the market is currently paying. The most common method is a discounted cash flow model: forecast the free cash flows the business will produce in future years, then discount them back to today at a rate that reflects the time value of money and the risk involved. Simpler approaches apply a reasonable multiple to normal earnings, or value the company's assets. Value investors compare their estimate with the market price and consider buying when the price is well below it.

The concept is sound, since an asset is ultimately worth the cash it will return to its owners, but any estimate is only as good as its assumptions. Small changes in expected growth or the discount rate can change the answer dramatically, so intrinsic value is best thought of as a range rather than a precise number, and two careful analysts can reach very different figures. This uncertainty is why value investors insist on a margin of safety, and why a share trading below someone's estimate of intrinsic value is not proof that it is cheap.