In its simplest form, intrinsic value is a measure of what an asset is worth. Its value refers to an investor’s perception of the inherent value of an asset, such as a product, company, stock, option, currency or real estate. The value can be anticipated or calculated and is calculated through fundamental analysis.
More specifically, in financial analysis, intrinsic value is associated with identifying, as accurately as possible, the underlying value of a company via its cash flow. Alternatively, in options pricing, it refers to the difference between the strike price of the option and the current price of the underlying asset. For more information on how these derivative products can be used in trading merger arbitrage, please refer to our article How to use Options in a Merger Arbitrage Strategy.
Intrinsic Value Valuation Factors
The intrinsic value of a stock attempts to boil out the external valuation influences and value the firm on its own merits. This leaves the internal factors upon which to base a valuation and can include such factors as a firm’s products, its management and brand recognition to determine intrinsic value. This measure is arrived at by means of an objective calculation or complex financial model, rather than using the currently trading market price of that asset.
As investors are interested in cash available to stockholders, these internal factors determine how much cash a company can expect to generate. It includes tangible and intangible factors. Intrinsic value is also called the real value and may or may not be the same as the current market value. Knowing an investment’s intrinsic value is useful for value investors who have a goal of buying stocks and other investments at a discount to this amount. This is especially true in mergers and acquisitions where valuing a firm is vital to avoid winners curse.
