![]() ![]() Yes, although stock market recovering and accounting scandals receding, the stock markets of the world remain dangerous places. Options that are not "in the money," meaning that the strike price is greater than the current share price, have no intrinsic value and are trading only for time value (i.e., the potential that the stock price could increase and drive the option price higher).The stock market is always a puzzle for the common investor, be it in terms of the number crunching, dabbling with difficult ratios or timing the market to maximise the gain. What's the intrinsic value of your options? The calculation is simple: ![]() You own four call options that entitle you to buy 100 shares per call option for $30. Suppose a given stock trades for $35 per share. Intrinsic value = (Stock price-option strike price) x (Number of options) There's a rock-solid way of calculating the intrinsic value of stock options that doesn't require any guesswork. Calculating the intrinsic value of options Asset-based valuation can often yield much lower intrinsic values than the other approaches. There is a downside to using asset-based valuation, though: It doesn't incorporate any growth prospects for a company. Subtracting the liabilities from the assets would give an intrinsic value of $300 million for the stock. What is RoboBasketball's intrinsic value using this approach? Let's assume the company's assets totaled $500 million. Intrinsic value = (Sum of a company's assets, both tangible and intangible) – (Sum of a company's liabilities) The formula for this calculation is straightforward: The simplest way of calculating the intrinsic value of a stock is to use an asset-based valuation. Using these figures, RoboBasketball's intrinsic value is: Finally, let's suppose the stock currently has a P/E multiple of 35.5. Assume that the company will be able to grow its earnings by around 12.5% over the next five years. Let's say that RoboBasketball generated earnings per share of $3.30 over the last 12 months. Where r = the expected earnings growth rate Intrinsic value = Earnings per share (EPS) x (1 + r) x P/E ratio Here's the formula for this approach using the P/E ratio of a stock: ![]() If you use a rate of return of 4%, the intrinsic value of RoboBasketball would be a little over $2.8 billion using discounted cash flows going out for 25 years.Ī quick and easy way of determining the intrinsic value of a stock is to use a financial metric such as the price-to-earnings (P/E) ratio. Based on the company's growth prospects, you estimate that RoboBasketball's cash flow will grow by 5% annually. You look at its current cash flow statement and see that it generated cash flow of $100 million over the last 12 months. Let's say you want to perform a discounted cash flow analysis for the stock of RoboBasketball, a fictional company that makes a remote-controlled drone that looks like a basketball ( ticker:DUNK). r is the rate of return you could get by investing money elsewhere.CF1 is cash flow in year 1, CF2 is cash flow in year 2, etc.Here's the formula you can use to calculate an intrinsic value using discounted cash flow analysis: You'll also need to gain a decent understanding of the company's growth prospects to make educated guesses about how cash flows could change in the future. You'll probably need to delve into the financial statements of the business (unsurprisingly, previous cash flow statements would be a good place to start). Estimating a company's future cash flows requires you to combine the skills of Warren Buffett and Nostradamus. Sum up the present values to obtain the intrinsic value of the stock.Calculate the present value of each of these future cash flows. ![]() Estimate all of a company's future cash flows.To perform a DCF analysis, you'll need to follow three steps: Some economists think that discounted cash flow (DCF) analysis is the best way to calculate the intrinsic value of a stock. ![]()
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