Intrinsic value

DEFINITION of Intrinsic value

Intrinsic value has two primary connotations in the finance world. In the options-trading world, the term refers to the difference between the option’s strike price and the market value of the underlying security.

WHAT IT IS IN ESSENCE

However, the most well-known usage occurs in security analysis. There, intrinsic value is the perceived value of a security (which may differ from its market value).

It takes the value of intangible aspects of a company into account. However, investors can never know everything about a company. And they can’t always predict which factors will negatively affect a stock. Companies whose assets happen to be primarily intangible, such as technology and other companies with a lot of intellectual property, may experience considerable differences between their market values and their intrinsic values.

HOW TO USE

Approaches to this can distinguish value investors from growth investors. Although growth investors aggressively rely on earnings estimates that could be wrong, too high. Or otherwise unreliable, value investors only buy stocks selling at a discount to their intrinsic value. And then wait for the fair worth of their investments to be realized. Even though both types of investors must face the prospect that their companies may falter, mature, or get so big that maintaining historical growth rates is impossible. So, the most value investors buy stocks with the expectation that the stock price will rise to match the intrinsic value of the company rather than the other way around.

For traders there are two ways to define it:

  • In shares trading, it can refer to the real value of a company as perceived by an investor. Some traders give prominence to strong fundamentals and others look at the potential for growth or market conditions.
  • In options trading, it is the difference between the underlying asset’s price and the option’s strike price. It is a way to calculate intrinsic value varies between the types of option. Incall options, it is the price of the underlying asset minus the strike price. But, in put options, it is the strike price minus the price of the underlying asset.

This means that a stock’s market value can differ significantly from an investor’s idea of its intrinsic value. Some investor may choose to buy or sell the stock because of believing there is a discrepancy in its current price and its actual worth. In this case, intrinsic value is similar to fair value.

Let’s say few words about extrinsic value.

In options trading, the extrinsic value is calculated as the difference between an option’s market price and its intrinsic value. If an option has a premium of $50 and an intrinsic value of $30, its extrinsic value would be $20.

Intrinsic value measures the inherent worth of a share, extrinsic value measures how much of its worth is derived from external factors.