Intrinsic Value
Intrinsic value is what a business is actually worth based on the cash it will generate over its remaining life, discounted back to today. It exists independently of the stock’s market price, and the gap between the two is where investment returns are born.
The math
The principle fits in one sentence: a business is worth the sum of its future free cash flows, discounted for time and risk. A company reliably producing 100 million dollars of free cash flow, growing modestly, is worth roughly 15 to 20 times that at ordinary discount rates: call it 1.5 to 2 billion.
The market may price it at 1 billion in a panic or 4 billion in a mania; the cash-producing machine is the same in both cases.
| Valuation | |
|---|---|
| Annual free cash flow | $100M |
| Intrinsic value (15 to 20x) | $1.5 to 2B |
| Panic price | $1B |
| Mania price | $4B |
Nobody computes intrinsic value exactly, and nobody needs to: you only need to know the price is far below any reasonable estimate.
The trap
Precision worship. A discounted cash flow model outputs whatever its assumptions whisper: move long-term growth by one point and the result swings by half.
The number with two decimals is the most dangerous number in finance. The equally common trap is the opposite: concluding that because valuation is imprecise, price is all that matters.
Imprecise anchors still hold better than no anchor.
The move
Estimate in ranges, buy only when price sits clearly below the low end of your range, and write down the assumptions so future-you can check where the estimate went wrong. Value the business as if you were buying all of it with your own money: the question is never what the ticker might do, but what the machine produces.