What is the Intrinsic Value Formula? Try this Online Calculator…

Intrinsic value formula can help one to estimate ‘fair value’ of stocks. But why to bother about ‘intrinsic value’? Why not simply buy stocks at an available market price?

Because stocks will be profitable only if one buys them at a price below its intrinsic value. In fact, Benjamin Graham (The Guru to Warren Buffett) says that, stocks must be bought at a ‘discount‘ to its intrinsic value.

What means by discount? Suppose a stock’s market price is Rs.100. Upon estimation, its intrinsic value comes out to be Rs.90. In couple of months, market price of this stock fell from Rs.100 to Rs.80.

At this price level, the stock is said to be trading at a discount of 11.1% to its intrinsic value [(90-80)/90].

Market Price

Intrinsic Value Formula - market price, intrinsic value, overpricing

Market price is the current price of a stock at which one can buy and sell it. There is no partiality here. Even Warren Buffett has to buy stocks in stock market at its ‘market price’, like us.

But the difference between Buffett and us is in the awareness about intrinsic value. Warren Buffett will never buy a stock without knowing its intrinsic value. Why? Because he buy’s only those stocks which are available at a discount to its intrinsic value [Market Price less than Intrinsic Value] .

Intrinsic Value (Undervalued Stocks)

Intrinsic Value Formula - market price less than intrinsic value - growth potential

Warren Buffett aims to buy stocks at a price below its intrinsic value. Such stocks are called undervalued. What is the utility of undervalued stocks? Price of such stocks has a stronger tendency to move-up over time.

There can be two stages of price moving up:

  1. Levelling with Intrinsic Value: The first stage will be when the market recognises that the current stock price is undervalued. In this case there will be more buyers for this stock than its sellers. Hence its price will start moving up. This upward price momentum will continue till market price equals the intrinsic value. Read more about the concept of intrinsic value of stocks.
  2. Move towards overvaluation: Price of undervalued stocks will rise till it levels with its intrinsic value. This is like a certain logical growth. But often the forward momentum takes the price beyond the intrinsic value levels. This is where the stock starts to become overvalued. Read more about how to identify undervalued stocks.

For potential investors, the target should be to identify an undervalued stock, and buy it at a ‘discount’. Such stocks has greater potential to give delta returns as highlighted in the above infographics.

Intrinsic Value Formula

There is a book on value investing called “The Intelligent Investor“. This book is written by Benjamin Graham (The Guru to Warren Buffett). In this book he has mentioned a formula. This formula can be used to estimate intrinsic value.

Intrinsic Value Formula - The Intelligent Investor Book

The formula looks like this:

V = EPS x (8.5 + 2g) – (i)

  • V = Intrinsic Value.
  • EPS = Earning Per Share.
  • 8.5 = Assumed fair P/E ratio of Stock.
  • g = Assumed future growth rate (7-10 years).

In year 1962, Benjamin Graham updated the above formula to make it more flexible for future use. He inserted a ‘multiplying factor’ in the original formula. He called the multiplying factor as interest rate factor. After this small tweak, the updated formula looks like this:

Intrinsic Value Calculator for India - 2
  • 4.4 = Interest Rate of AAA Corporate Bonds in USA in Year 1962.
  • Y = Interest Rate of AAA Corporate Bonds in USA as on today.

Ben Graham’s Formula Updated for India

The above formula has many limitations. Experts of fundamental analysis of stocks prefer going into more detailed calculation to estimate intrinsic value. Read more about doing detailed stock analysis in MS Excel.

In the above formula of Benjamin Graham, there is a factor of “4.4”. This makes it suitable for stocks trading only in USA. There must be a different factor for Indian stocks, right? Why?

Because in the denominator there is a factor of “Y”. What is Y? Interest rate of AAA corporate bonds operating in a country (for us it is India). Hence, the numerator must also be tweaked for India.

Hence, I though to use a slightly different form of this formula for my stock’s analysis. But the problem was, nowhere I could find the yield of AAA Corporate bonds of India in 1962. So I thought to use the below assumption to reconfigure the multiplying factor:

Intrinsic Value Formula - Corporate Bond Yield

Hence the revised Benjamin Graham’s intrinsic value formula looks like this:

Intrinsic Value Formula - Corporate Bond Yield Revised Formula

[Intrinsic value calculator based on Benjamin Grahams Formula]

Conclusion

Benjamin Graham’s intrinsic value formula is only a starting point of stock valuation. It can only give a rough idea of the intrinsic value of stock. But one must not base their decision on this formula alone.

It is better to cross check true value of stocks by using more detailed tools of fundamental analysis. I personally use my stock analysis worksheet to do a more detailed analysis of my stocks.

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31 Comments

  1. Hello
    please help me to calculate graham number of the company. i am a research scholar. i want to see it for pre and post period graham analysis. it is a growth stock

  2. Hi Mani,
    Goof article. Challenge is how to find the future growth of the compnay. Do you have any advice on how to estimate this figure (g)?
    Thanks.

    • Future growth rate can be estimated by seeing the past trends. Sometimes, company’s also share their future forecasts. But I agree, it is a challenge 🙂

  3. Thanks.content was very good.I was wondering from last one year to learn how to calculate intrinsic value of the stock.

  4. Hi Mani,

    Thanks for such wonderful information. I tried using teh formula however it is difficult to find undervalued stocks. Most of the top performing stocks are overpriced.

    Regards,
    Deepak P

    • You are right. At a point in time where Sensex is close to 40,000 points, this is what is expected. You can see my watchlist, may be you can find some undervalued ones there.

  5. HI, you wrote : 1962 in India, AAA Corporate bonds must have been yielding 7.9% per annum. Is this your assumption, or did you take it from a source?

    • I have made a guess. I have gives its rational in “Limitation of Graham’s Formula”. Thanks for asking.

  6. First of all thank you for this wonderful post for helping to make understand the intricacies of intrinsic value. I am completely new to investment and my curiosity led me to this page when I googled for it. As you have said, this is deep knowledge and maybe I have grasped it superficially but then atleast there has been a start for me. I just wanted to ask, if we follow the concept the intrinsic value, should WE ALWAYS resist from overpriced stock even if they good stocks? Because depending on the times, most of the good stocks will be most likely overpriced at current time and should I be patient to wait for its prices to drop down (Should we really wait even if its very long) ?

    • Purchase of overpriced stocks are never advisable, no matter how big is the brand name. Thanks for asking.

  7. Ajanta Pharma Example- Last 5 year EPS has come down to 48.6 from 62.8 ie 23 % negative growth. Which growth rate is to be assumed ? and what will be intrinsic value as per your excel sheet ?

    • Future growth rate assumption cannot be made by only looking at EPS. One has to see the other growth metrics to arrive at an assumption. Thanks.

    • This should be an estimation for each stock. How to estimate? See last five years sales growth, profit growth, EPS growth, Net worth growth etc. This gives a fair idea. Thanks for asking.

  8. Is assuming 8.5 as the PE in the formula also suffering from the same problem as 4.4% interest rate factor for AAA rated corporate bonds in 1962 – pertaining to a period of time and not dynamic to suit the present times ? Maybe the reference may need to be made to Industry PE in the past 3/5 years or so ? In this case, multiple of 2X Growth Rate is also called to question, making the formula more subjective.

    • Roughly it can be estimated by looking at pat 10 year growth rates of the following stock metrics:
      – Sales.
      – EPS.
      – Free Cash flow
      – Net Worth.
      – Asset.

  9. Dear sir,
    Probably a basic question from a beginner. when is it recommended to sell the stock?
    Should we sell the stock when market price rise above calculated intrinsic value or value investors should hold forever? when to realize profit?

    • It is a tough question. The answer can get complicated.
      But I follow this rule, which is simpler:
      “Before purchase, fix a target price (with respect to the intrinsic value). Once the stock price breach the target price, sell. Make sure to reinvest all money back into a value stock”.

  10. In your stock analysis worksheet you are calculating intrinsic value by different methods. That’s fine. But what is the basis for you arrivng an intrinsic value by averaging the values of all the methods. If you just take only 2 or 3 methods the average will be different and hence intrinsic value too. Please justify.

    • The estimated intrinsic value is not average.
      It is better to consider weighted average when dealing with intrinsic value.

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