The value of an asset, whether it be a stock, a piece of property, or a watch, is vital in determining how much you should pay for it and how much you should sell it for. Intrinsic value is also a concept you should be aware of if you want to make money with your investments.
Whether you trade forex, stocks, or buy and sell trading cards, you need to understand the value and intrinsic value. Here is how it is calculated and why you need it.
What is Intrinsic Value?
In terms of stocks or a business, intrinsic value isn’t as easy to determine as the price for a painting, for example. The intrinsic value of an asset isn’t what someone would pay for it but rather a value that is calculated and uses multiple factors to determine its future worth.
Intrinsic value is also different from relative value. The latter is determined by the value of your asset compared to other assets in the same market, whereas intrinsic value is the value of the asset in isolation.
Why You Should Calculate It
With regards to stocks, you are buying them so that at some point, they can grow and eventually make you money. While this goal may seem simple, choosing the right stock or asset that can do this can be tricky.
The best stocks to buy are the ones you can find that are trading below their intrinsic value. This means they are trading below a point they are worth, not below a point due to price fluctuations, buying, and selling, etc.
Therefore, calculating the intrinsic value of an asset allows you to predict whether or not it will go up or down in price and at what price you should purchase it.
Determining the intrinsic value of a stock is far easier than determining the value of a business. The equation is simple, (Sum of a company’s assets, but tangible and intangible) – (Sum of company’s liabilities)
If Apple’s assets are worth, for example, $500 million, and its liabilities are worth $200 million, its stock is worth $300 million. The downside of this method is that it doesn’t incorporate potential growth, but it is a good place to start.
Intrinsic Value of Gold
Intrinsic value doesn’t just apply to stocks or businesses but also to commodities like gold. Precious metal has always been used as a hedge against inflation, and its status as holding intrinsic value has been up for debate for ages.
On the one hand, it does not generate cash flow and can also often only be worth what someone is willing to pay for it. On the other hand, you can use the relative valuation method and compare its worth to silver, for instance. This will show that gold does have value to a degree.
Intrinsic Value of Crypto & NFTs
It is a different story with crypto and NFTs, though. One of the best selling points about crypto is that it isn’t attached to any bank. While this is appealing, it means that it has no backing and, therefore, no intrinsic value.
Right now, a Bitcoin is worth whatever someone wants to pay for it; the price can go to $100,000, or it could go to $0. The same thing can be said for NFTs; since they are technically all art pieces or collectibles, the market determines the value and price. The NFT itself does not hold any value outside of that.
Intrinsic Value Challenges
One of the biggest challenges you will face when determining intrinsic value is that it is incredibly subjective. Not only are their different ways to calculate it, but it is also based on numerous assumptions.
Even if you make accurate assumptions, they are very sensitive to change over the long and short term. You then have to include confidence and predictions, which are also both incredibly subjective.
The problem is that you are trying to predict the future. While you may get close, the future is still entirely unpredictable. Any expert will tell you that you can give the same information to 20 professionals who do this for a living, and they will each come back with a different intrinsic value for the same thing.