How to Calculate the Intrinsic Value of Shares?

Before deciding to buy stocks, an investor needs to know what is the value of the share he or she intends to buy first. This leads to questions like what is the meaning of intrinsic value, intrinsic value of a share and finally, "How to Calculate the Intrinsic Value Shares?". 

So let us address the concepts one by one.

Intrinsic Value

Every thing in this world has an intrinsic value. For example one 500 rupee note has a value of 500 one rupees. Not a penny more or, not a penny less.

But how can we say this with conviction?

Well will any same person take a 500 rupee note and exchange it for more than five 100 rupee notes? Similar will we accept four 100 rupee notes in return for a 500 rupee note?

Therefore we can safely conclude that the intrinsic value of a five hundred rupee note is equal to 500 one rupees or five hundred rupee notes.

Intrinsic Value of Share

As with the five hundred rupee note, a share also has an intrinsic value. Any wise investor, who knows the inherent value of a share will never buy the stock above it's intrinsic value. She will be glad to buy the share if it is trading in the stock market below its intrinsic value. Buy is an understatement, in fact, she will pounce on the opportunity and grab the shares with both her hands.

But, is it possible that shares can be available below their intrinsic values?

Of course yes!

The stock market is a highly irrational place.

Now the discussion is getting excited with the prospect of being able to buy stocks below their fundamental values, is it not?

So, now it is important for us to know how to calculate the intrinsic value of shares, and let us address the question.

Calculating Intrinsic Value of a Share

The intrinsic value of the share of a company is essentially calculated based on two factors as follows:

1. Price to Earnings (PE) Ratio
2. Price to Book Value (P2BV) Ratio

Example Calculation of Intrinsic Values of Shares of NMDC and SJVN

Let us consider a live example of SJVN Ltd. and NMDC Ltd., based on the facts existing on 23rd September 2016.

In case of NMDC Ltd., to be on the safe side we have taken the minimum of the two intrinsic values of Rs.68.80 and 113.34, and rejected it. However please note that NMDC Ltd. is a wonderful company. I continue to buy its shares even today. Its PE Ratio deteriorated on account of two recent and temporary developments as follows:

1. The EPS deteriorated steeply on the back of a meltdown in global commodity prices. The price of iron ore has recovered to a great extent and I firmly believe it regain further.
2. The Indian stock markets have rallied in the recent past and pushed up the prices of all the shares across the board, which has pushed up the PE Ratio.

Caution:

Investment decisions are not simply based on the intrinsic value calculations shown above. A rigorous investigation of the company’s performance and prevailing market conditions described in the article “What are the Factors to be Considered Before Investing in a Company?”.

Related Links:

• How to Find The Fair Price of A Stock?
• What is 'Price to Earnings Ratio'? - Presentation
• How to Calculate ‘Price to Earnings Ratio?
• How to Calculate 'Earnings Per Share' or 'EPS'?
• Definition of Book Value per Share
• What is ‘Price to Book Value? - Article

Conclusion

To conclude, Price to earnings and Price to Book Value Ratios are the two key metrics employed in finding the intrinsic value of the shares of a company. We also learnt how to calculate the intrinsic value of share.

How to Choose the Right Mutual Fund to Invest?

Choosing a mutual fund is very crucial and while selecting a mutual fund following factors shall be kept in mind:

Vintage: 

For how long the fund has been in business - the longer the better, for in general more one is engaged in a particular trade more intimately one knows that business. UTI Mutual Fund is the pioneer in India.

Nature of Ownership: 

I will prefer and advise government owned or public sector (PSU) mutual funds for the following two reasons:

Though slow and inefficient in providing good customer service, generally PSUs do not take  customers on a ride through the fine print in the contracts.

In case the organisation gets into financial troubles, the government will step in with the rescue-act.

Size: 

Size does matter. Bigger the size safer it is. One can take the assets under management (AUM) as the parameter to measure the size. India’s Top Ten Mutual Funds command over 80% of the total assets under management.

Growth Funds: 

Funds fall under two categories namely income and growth funds. While income funds distribute regular dividends (some times obnoxiously out of capital instead of profits) growth funds reinvest the profits. For long term wealth creation, growth funds are preferable.

Diversified Index Funds: 

Well diversified index funds are preferable for the following advantages:

1. Diversity produces safety
2. Index funds are passive and therefore involve lower fund administration cost

Conclusion:

In conclusion careful consideration is required while choosing the right mutual fund to invest in for the purpose of attaining financial freedom and wealth creation.

Related Links:

List of Top Ten Mutual Funds in India by Assets Under Mangement

Why My Friends Lost or Earned Only Meger Returns from Investments in Both Stocks and Mutual Funds?

How Frequent Changes to Mutual Fund Portfolio Affect Investor Interest?

Why People Entrust Their Funds With Mutual Funds?

Is there a Special Benefit in Being Invested For a Long Time in a Debt Fund?

What Is The Difference Between Dividend and Growth Fund. Which Is Better?

What are the rules of thumb for investing a lump sum amount into a mutual fund?

Can we use money from mutual fund for home loan repayment?

A Few Mutual Fund Examples

How To Generate Passive Income?

How to Attain Financial Freedom?

Ability to maintain a simple lifestyle without having to work is financial freedom. A majority of people has no option but work to make a living. Only a minuscule proportion of the population can afford to live without the necessity for earning a living. One may wish to call this segment of people rich but this term is actually not correct. They have certainly attained financial freedom but they need not necessarily be rich. While all the rich certainly enjoy financial freedom, all those financially free may not be rich. Financial freedom is an important milestone on the way to richness.

Financial Freedom

What does financial freedom mean, technically?

We have already understood that financial freedom means a person need not necessarily work for a living. It means one should earn incomes that are not directly dependent on the persons labor. These incomes are called passive ncomes. Examples of passive incomes are:

• Rent
• Interest
• Dividend

On the other hand, income earned out of efforts like salary, fees earned by professionals like doctors, solicitors, brokers, profits earned out of business are all active incomes. Active incomes stop the moment the earner stops working – they are totally and directly dependent on the skills, knowledge, competence and efforts of the person.

Every person will surely be earning some passive income in the form of interest from the bank on the savings and fixed deposit accounts. A few must already be earning rent from real estate like residential homes, shops, industrial sheds they own. In the case of a majority of ordinary folks, the passive incomes are not significant. They simply constitute a very small part of their total income. The passive income is just not sufficient to maintain the person’s present lifestyle without the need for that person to work.

When the proportion of passive income becomes significantly large and becomes able to sustain the person without he or she having to work, then that person is said to have attained financial freedom.

We will examine the income, expense and investment patterns of two individuals. One is already financially free and the other is not yet.

Passive Incomes per month	Not Free, Yet ($)	Financially Free ($)
Interest	100	2000
Dividends	0	1000
Royalty	0	3500
Rent	550	0
Active, occupational income	4000	1500
Total monthly  Income	4650	8000
Present monthly lifestyle expenses	4500	4500
Surplus	150	3500
Investment for generation of passive incomes in future	0	3000
Surplus Income lying in savings account in bank yielding low interest	150	500

When we study the financial information of the two individuals we find that the financially free individual has passive income of $6500 as against his monthly lifestyle expenses of $4,500, leaving a surplus of $2,500 for investment and consequent creation of additional passive income. Please also note that despite having total income of $8,000, far in excess of present cost of living, the person has wisely not increased the lifestyle expenses. Also noteworthy is the fact that even though this individual has already attained financial freedom, is still having active income, indicating active pursuit of a career. On the other hand the other person has little investible surplus. This person has to increase the active income as well as reduce the living costs and has a long way to go before becoming financially free.