How To CALCULATE INTRINSIC VALUE of a STOCK?

Summary

In this video, the presenter explains how to calculate the intrinsic value of a stock, a concept made famous by Warren Buffett. By using a simple, real-world example of a bakery, viewers learn how to assess a company’s true value through financial analysis and the Discounted Cash Flow (DCF) method. The video emphasizes the importance of margin of safety in investments, understanding that stock prices can differ greatly from intrinsic values. The presenter also discusses how tools like P/E ratios and stock screening platforms can aid in identifying undervalued stocks for better investment decisions.

Takeaways

• 😀 Warren Buffett emphasizes the importance of the 'margin of safety' when investing, meaning buying stocks at a price lower than their intrinsic value.
• 😀 To calculate the intrinsic value of a stock, one must assess its underlying quality, profitability, and future potential rather than focusing on market price alone.
• 😀 A simple method to determine a business’s intrinsic value is using the formula: intrinsic profit / required rate of return.
• 😀 Intrinsic value is determined by calculating the present value of all future cash flows, considering factors like risk and required return rate.
• 😀 When valuing a business, we should focus on its quality and ability to generate consistent profits, which can be reinvested to generate returns.
• 😀 The intrinsic value of future profits decreases as time progresses, a concept known as 'discounting'—where future money is worth less today.
• 😀 The 'present value' of an asset reflects the expected future returns discounted back to today's value based on the required rate of return.
• 😀 The Price-to-Earnings (P/E) ratio is useful in understanding how much investors are willing to pay for a company's earnings. A high P/E ratio may indicate overvaluation.
• 😀 Stocks can be undervalued or overvalued based on intrinsic value calculations, with undervalued stocks providing better long-term returns.
• 😀 The ultimate principle in asset valuation is: 'The value of any asset is the present value of all future expectations'. This means investments should be evaluated based on their potential future returns rather than current market price.

Q & A

What is the importance of 'margin of safety' in investing?

The margin of safety refers to buying a stock at a price lower than its intrinsic value, ensuring a cushion against potential losses. It allows investors to reduce risk by purchasing stocks at a discount.

What is intrinsic value and how do we calculate it?

Intrinsic value represents the real value of a stock or company, based on its fundamentals, such as earnings, assets, and liabilities. It can be calculated using various methods like discounted cash flow (DCF) or price-to-earnings (P/E) ratios.

Why is it important to calculate the intrinsic value of a company before purchasing its stock?

Calculating intrinsic value helps investors assess whether a stock is undervalued or overvalued, ensuring they make informed decisions. By comparing intrinsic value with market price, investors can avoid buying overpriced stocks.

What does it mean that stocks are auctioned in the market?

Stocks are auctioned because their prices are not fixed but are determined by supply and demand. The price fluctuates based on market participants' bids, and popular stocks tend to have higher prices.

How can an investor determine if a stock is undervalued?

An investor can determine if a stock is undervalued by calculating its intrinsic value and comparing it with the market price. If the market price is lower than the intrinsic value, the stock may be undervalued.

What role does quality and risk analysis play in stock evaluation?

Quality and risk analysis help determine the company's financial health and future potential. By assessing these factors, investors can make better decisions regarding whether to invest in a company.

What is the formula used to calculate the intrinsic value of a business?

The formula to calculate the intrinsic value is: Intrinsic Value = Profit / Required Rate of Return. For example, if the profit is ₹10 and the required return is 14%, the intrinsic value would be ₹71.42 (₹10 / 0.14).

How does the concept of discounted cash flow (DCF) affect stock valuation?

Discounted cash flow (DCF) involves bringing future cash flows to their present value using a discount rate. This helps determine the current value of future profits and adjusts for the time value of money.

What is the significance of the P/E ratio in stock evaluation?

The Price-to-Earnings (P/E) ratio is used to evaluate if a stock is overvalued or undervalued. It shows how much investors are willing to pay for each rupee of earnings. A lower P/E ratio can indicate undervaluation, while a higher P/E ratio may signal overvaluation.

Why do some investors choose to buy expensive stocks despite high P/E ratios?

Investors may buy expensive stocks with high P/E ratios if they expect the company's future earnings and stock price to rise significantly. However, this approach carries risks as the stock may not meet growth expectations.