Methods to Find the Intrinsic Value of Real Estate, Investments, and Companies
The term intrinsic value refers to the real or actual value of a security, stock, or company. Real estate, equity, and options have intrinsic value. In the case of options, this is the difference between the strike price and the price of the underlying stock.
Real Estate Holdings
Investments turn out profitable when the underlying value is greater than the purchase price. The goal is to make profits through effective market pricing. One way to go about this is to determine the replacement cost. In essence, this is what you would pay to acquire an asset or real estate of equal value. The replacement cost of a business, for example, is based on liens and assets such as accounts receivable, stock, machinery and equipment, buildings, etc. Speaking of real estate, adjustments are necessary to account for replacement rents and depreciation. You may want to look into costs such as:
A property that costs $120,000 to build and is sold for $165,000 is a good investment. The profit is $45,000. In times of economic growth and development, the replacement cost may increase to $140,000, and the sales price will go up to $175,000, creating a profit of $35,000. Home prices go down when there are fewer buyers on the housing market, and the replacement cost decreases to $110,000, resulting in smaller profits made. As a rule, the best time to buy a house is when replacement costs exceed home prices. The opposite is true for home sellers.
You may also want to look at cash flows such as property and maintenance taxes, inflation, rent, and others.
Options
When investing in options, two factors should be taken into account – the time and intrinsic value. There is a difference between put and call options. A put option gives sellers the right to sell a financial product or a commodity at a specified price while a call option gives the right to buy. The intrinsic value of a call option is equal to the difference between the underlying and strike price while for put options, it is the difference between the strike and underlying price. If the premium of a call option is $6, this means that the seller gets $6 for each share while the buyer pays this amount. The time value will be $1 in case the intrinsic value is $5 ($6 - $5 = $1).
Equity
Discounted cash flow valuation is usually used to determine the present or intrinsic value of a company. Another option is to look at the book value and ongoing operations of the company. Some financial experts use the Gordon Model whereby the current stock price is calculated by dividing the next year’s dividends by the difference between the constant cost of capital and the growth rate. Another option is to use the discounted cash flow method. The first step is to multiply the growth rate with the cash flows and divide the NPV by the discount rate. Determine the projected cash flows for a period of 10 years and add the net present values. You will find the sell off value by multiplying the last year’s figure by 12. Then add up the cash equivalents, cash, and the values you’ve came up with. If you find this method time consuming or difficult, you can use an online calculator to determine the value of the discounted cash flows. Just enter the current stock price, margin of safety, growth rate, and current earnings. You may have to plug in the purchase price, intrinsic value per share, and current margin.
The Benjamin Graham Formula
If you are good at math, you can use the Benjamin Graham formula – V* = EPS x (8.5 + 2g) where g is the growth rate within a 7 – 10 year period, 8.5 is the P/E base, and EPS is the earnings per share within a 12-month period. The formula was revised in 1974. If you use this method, you should take other factors into account, including current assets and their quality, debt to equity ratio, the current asset value, the net current asset value, and others.
Financial experts also use indicators such as the expected, option time, and net realizable value.
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