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In finance, the intrinsic value of a stock is the perceived value of what the stock is actually worth. This value may differ from the actual market price, which is a product of what current investors are willing to pay. By using the intrinsic value, investors hope to identify whether a stock is either overvalued or undervalued and then react accordingly. Methods for determining this value vary among investors, who may choose to heed numerical evidence or follow qualitative factors to figure out a stock's actual worth.
The market price of a stock at any given time certainly is related to the overall health of that stock, but it can also be skewed by current market trends. If the market price fails to reflect what a stock is actually worth in either the near future or over the long term, investors may have an opportunity to take advantage. When accurately estimated, the intrinsic value of a stock can be more relevant to the overall strength or weakness of a stock and therefore is a crucial piece of information to the investor.
Intrinsic value becomes so vital in investing because it allows investors to identify a bargain. For example, a stock may fall into a slump due to current circumstances beyond its control, such as an overall economic slump or a new competitor in the market. The slumping price may not be indicative of what the stock has done in the past or what it is capable of achieving. If an investor can find the actual value of the stock hidden beneath the current low price, then he or she will get a bargain by buying the stock.
What makes intrinsic value somewhat problematic is that there is no surefire way of coming up with an accurate determination. Some investors prefer to look at qualitative standards such as company leadership, brand name, business model, and other more abstract indicators of strength to reach the actual value. These methods can certainly be effective if the investor is savvy enough, but since they are essentially judgment calls, these methods are far from an exact science.
Investors can also look at actual numerical totals to calculate intrinsic value, hoping that this concrete evidence will lead to a more accurate assessment of a stock's worth. These calculations, which vary in formula depending on the investor, usually use earnings-per-share totals and can actually come to a numerical value that can then be compared to the stock price. This method can also use future earnings per share estimations to yield a clearer long-term picture of a stock's health. The drawback is that earnings per share is a relatively useless statistic for young stocks that don't yet have positive earnings.