How to Calculate Intrinsic Value of Stock ?

 How to Calculate Intrinsic Value of Stock ?

Calculating the intrinsic value of a stock is a fundamental concept in value investing. It represents the estimated true worth or fair value of a stock based on an investor's analysis of a company's fundamentals. There are various methods to calculate intrinsic value, with two of the most common approaches being the dividend discount model (DDM) and the discounted cash flow (DCF) model.

Here's an overview of each method:

Dividend Discount Model (DDM):

The DDM is typically used for companies that pay dividends to their shareholders. It calculates the intrinsic value of a stock by discounting the expected future dividends. The formula for the DDM is as follows:

Intrinsic Value = (D1 / (1 + r)) + (D2 / (1 + r)^2) + ... + (Dn / (1 + r)^n)

• D1, D2, ..., Dn:
• These represent the expected future dividends for each period (usually years) into the future.
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• r: This is the required rate of return or discount rate, which is the rate of return an investor expects to earn on their investment.

To use the DDM, you need to estimate the future dividends a company will pay and determine an appropriate discount rate based on factors such as risk and opportunity cost.

Discounted Cash Flow (DCF) Model:

The DCF model is a more general method used for companies that may not pay dividends or where dividends are not the primary source of value. It calculates the intrinsic value of a stock by discounting the expected future cash flows generated by the company. The formula for the DCF model is as follows:

Intrinsic Value = CF1 / (1 + r)^1 + CF2 / (1 + r)^2 + ... + CFn / (1 + r)^n

• CF1, CF2, ..., CFn:
• These represent the expected future cash flows for each period into the future, which can include operating cash flows, free cash flows, or any relevant measure of cash generation.
• 
  
• r: This is the required rate of return or discount rate, similar to the DDM.

To use the DCF model, you'll need to make forecasts for future cash flows, and you'll need to determine an appropriate discount rate.

Estimating future cash flows or dividends and selecting the appropriate discount rate involves a degree of subjectivity and risk. Small changes in these inputs can significantly affect the calculated intrinsic value. Additionally, intrinsic value calculations are only as reliable as the accuracy of the assumptions and data used, so thorough research and analysis are essential when using these methods to make investment decisions. It's also a good practice to compare the calculated intrinsic value to the current market price to determine whether a stock is undervalued (if intrinsic value > market price) or overvalued (if intrinsic value < market price).