Intrinsic Value — What It Means and How to Calculate It

Definition

Intrinsic value is an estimate of what a stock is actually worth, based on the cash it's expected to generate in the future — as distinct from its current market price. The gap between intrinsic value and market price is what value investors call the margin of safety.

Three ways to estimate intrinsic value

There is no single "correct" intrinsic value — different models give different estimates depending on their assumptions. The three most common approaches:

Discounted Cash Flow (DCF)

Projects future free cash flows, discounts them to present value using WACC, adds a terminal value. Most versatile — works for any cash-generating business.

IV = Σ [ FCFₜ ÷ (1 + WACC)ᵗ ] + TV − Net Debt

Best for: Most companies with positive free cash flow

Dividend Discount Model (DDM)

Values a stock from its expected future dividends. Uses cost of equity as the discount rate (not WACC, since dividends flow to equity holders only).

IV = D₁ ÷ (Ke − g)

Best for: Banks, insurers, mature dividend payers

Graham Number

A conservative heuristic combining earnings and book value. Not a present-value model — it's a screen, not a valuation.

IV = √(22.5 × EPS × BVPS)

Best for: Quick conservative screen for deep-value candidates

Worked example

Worked example: Microsoft (MSFT)

Market price$442

DCF intrinsic value (base case)$410

Margin of safety = ($410 − $442) ÷ $410−7.8%

A negative margin of safety means the market price exceeds the model's estimate — the stock appears fully valued or slightly overvalued on DCF assumptions. This doesn't mean "sell" — it means the current price already reflects the expected growth. Changing assumptions (higher growth rate, lower discount rate) would produce a higher intrinsic value.