What is Intrinsic Value?

What is a Business Worth?

In the simplest terms, a business is worth the value it can create over its lifespan. That value to you, as a shareholder and owner, is the amount of real cash it produces, year after year, through its lifetime.

Suppose you own a chocolate factory. You can make a million chocolate bars every year. Each bar costs you $1 to make (paying employees, buying raw materials, keeping the lights on, shelling out taxes, amortized and depreciated capital expenses) and sell (shipping to stores, marketing, setting up coupons and other promotions).

You sell your amazing chocolate for $2 per bar. This puts $1 in your hand for every bar sold. If you sell each chocolate bar as it comes off the assembly line, that's a million dollars in your pocket every year. Not bad.

When is a million dollars worth more than a million dollars? What's that million dollars a year that your business can generate worth to you? That makes the question more interesting.

Intrinsic Value Measures the Money a Business Can Generate

Suppose your factory will last for ten years, at which time it's obsolete or everyone's sick of chocolate or you've decided to sell everything become a coconut farmer on a deserted tropical island. (Of course you sell your coconut to another chocolate factory, but that's not the point.)

If you sell your factory, what can you get for it?

The intrinsic value of the business is how much money it can produce for its owners over a specific time period, plus the value of its assets. For your chocolate factory, that's $1,000,000 every year for ten years plus whatever you can sell off the assets for. Your intrinsic value is, thus, at least $10 million dollars. Wow!

Valuing the assets is more difficult. Maybe you will find someone to pay you to turn your factory into an awesome new battery technology factory. Maybe you will find someone to turn it into an indoor skate park. Obviously the real world is more complicated than a magical chocolate bar factory. The factory and its machines are worth something. So is the land it is on. You can get an estimate of the liquidation value of those assets (see Net Asset Value).

How to Calculate Intrinsic Value Using the DCF Method

The most common way to calculate intrinsic value is through discounted cash flow analysis or DCF. This method projects future cash flows and discounts them back to their present value. While the chocolate factory example earlier used simple addition, real DCF calculations account for the time value of money.

The basic formula looks like this: the intrinsic value equals the sum of each year's cash flow divided by one plus the discount rate raised to the power of that year. Add to that a terminal value representing the business worth beyond your projection period, also discounted back to present value.

Okay, that's a mouthful (and not of chocolate). Here is a practical step by step process:

Step 1: Find Free Cash Flow. Look at the company's annual SEC filing (the 10-K report). Find the cash flow statement and identify free cash flow. This is typically operating cash flow minus capital expenditures. For example, if a company generates $50 million in operating cash and spends $10 million on equipment and facilities, its free cash flow is $40 million.

Step 2: Estimate Growth Rate. Review the past five to ten years of free cash flow to see the company's growth trend. Be conservative. Mature companies might grow at 3 to 7 percent annually. High-growth technology companies might sustain 15 to 20 percent for a few years, but few maintain that pace for a decade. Use historical data and industry research to make your estimate.

Step 3: Choose Your Discount Rate. This rate reflects your required return and the investment's risk. Use 8 to 10 percent for stable blue-chip companies with predictable cash flows. Use 12 to 15 percent for growth stocks with more uncertainty. For speculative or turnaround situations, consider 15 percent or higher. Some investors use the company's weighted average cost of capital (WACC).

Step 4: Project Future Cash Flows. Take your starting free cash flow and apply your growth rate for each year in your projection period (typically 10 years). If you start with $40 million and use 7 percent growth, year one would be $42.8 million, year two would be $45.8 million, and so on.

Step 5: Discount Each Cash Flow. Divide each future year's cash flow by one plus your discount rate raised to the power of that year. For year one with a 10 percent discount rate, divide by 1.10. For year two, divide by 1.21 (which is 1.10 squared). This gives you the present value of each future cash flow. Sum all these present values.

Step 6: Calculate Terminal Value. Your business does not stop generating cash after 10 years. Estimate its value beyond your projection using a conservative multiple (like 15 times the final year's cash flow) or a perpetuity growth model. Then discount this terminal value back to present value using your discount rate raised to the power of 10.

Step 7: Add It All Up. Sum your discounted cash flows from steps 5 and 6. This total is your estimate of the company's intrinsic value. For a per-share value, divide by the number of shares outstanding.

Real World Examples from 2025

Let's look at how intrinsic value calculations work with actual companies trading today.

Apple (AAPL) - November 2025. Apple generated approximately $111 billion in free cash flow over the trailing twelve months. The stock trades around $277 per share with about 15.3 billion shares outstanding. If we project 5 percent annual growth (conservative given Apple's mature market position) and use a 9 percent discount rate over 10 years, plus a terminal value of 15 times the year-10 cash flow, we might arrive at an intrinsic value around $320 per share. This suggests the stock could be trading below its intrinsic value, potentially offering value investors an opportunity. Of course, your own analysis might use different assumptions based on your view of iPhone sales trends, services growth, and competitive pressures. Sources: Apple Investor Relations and SEC 10-K filings.

Walmart (WMT) - November 2025. Walmart stock trades around $107 per share with adjusted earnings per share of about $2.51 for the trailing twelve months. The company generates roughly $15.6 billion in annual free cash flow. Using a 10 percent discount rate and projecting 4 percent growth (reflecting Walmart's mature but stable retail position), an intrinsic value calculation might yield approximately $95 per share. This suggests Walmart could be trading slightly above intrinsic value, priced for continued growth in e-commerce and international markets. Investors should verify these numbers with Walmart's latest quarterly reports and consider factors like competition from Amazon and changing consumer behavior. Source: Walmart Q3 2025 Earnings Report.

These examples show how intrinsic value calculations provide a framework for thinking about what a business is worth. Notice that small changes in your assumptions about growth rates or discount rates can significantly affect the final number. This uncertainty is why Benjamin Graham emphasized buying with a margin of safety.

Intrinsic Value is Inexact but Useful

Calculating intrinsic value isn't an exact science. You'll probably have to invest more in the factory to keep it running and to keep your workers happy. These things wear down over time. Furthermore, you might not be satisfied making only a million dollars every year. You could cut costs or raise prices or make more candy bars—and pay your workers more every year too.

Hopefully it is obvious now that intrinsic value calculations are baseline estimates. The simplest (yet still accurate and very important) way to measure the value of a business is to figure out how much money it can make over the next several years. What does it pay you to own it?

Common Mistakes When Calculating Intrinsic Value

Even experienced investors can make errors in intrinsic value calculations. Recognizing these common pitfalls can help you make better estimates and avoid costly mistakes.

Using unrealistic growth rates. It is tempting to project 20 or 30 percent annual growth for a company you like, but very few businesses sustain such rates for a decade. Historical data shows that even the best companies typically see growth slow as they mature. A large company growing revenues at 25 percent annually will double in size every three years, which becomes increasingly difficult as the company gets bigger. Use historical growth rates or conservative industry averages, typically 3 to 7 percent for mature companies and 10 to 15 percent for proven growth companies.

Ignoring the discount rate. Your discount rate profoundly affects the final intrinsic value. A stable utility company with predictable cash flows deserves a lower discount rate (8 to 10 percent) than a speculative biotech company with uncertain future revenues (15 percent or higher). The discount rate should reflect both your required rate of return and the investment's risk level. Do not use the same rate for every stock you analyze.

Forgetting about the margin of safety. Even if you calculate an intrinsic value of $100 and the stock trades at $90, Benjamin Graham would not necessarily recommend buying. He advocated purchasing stocks at 30 to 50 percent below intrinsic value to provide a cushion for errors in your estimates. If your intrinsic value is $100, consider waiting until the stock falls to $50 to $70 before investing. This margin of safety protects you when your projections prove too optimistic.

Confusing earnings with cash flow. Many beginners use net income or earnings per share in their calculations when they should use free cash flow. Earnings include non-cash charges like depreciation and stock-based compensation that do not reflect actual cash generation. A company can report positive earnings while burning cash. Always focus on free cash flow, which measures real money the business produces and can distribute to owners or reinvest for growth.

Ignoring debt and capital structure. Two companies with identical operating cash flows can have very different intrinsic values if one carries heavy debt while the other has a clean balance sheet. High debt increases financial risk, especially during economic downturns when revenues fall but interest payments remain fixed. Consider adjusting your discount rate upward for highly leveraged companies, or better yet, use WACC to account for both equity and debt costs in your calculation.

Overlooking competitive threats and industry changes. Your 10-year projection assumes the business will continue operating successfully. But what if a competitor introduces a superior product? What if regulation changes the industry? What if consumer preferences shift? Intrinsic value calculations work best for businesses with strong competitive advantages or economic moats that can protect their cash flows over time. Be skeptical of high valuations for companies in rapidly changing industries unless they have demonstrated staying power.

Intrinsic Value vs. Other Valuation Methods

Intrinsic value through DCF analysis is one of several ways to evaluate a stock. Understanding how it compares to other common methods can help you choose the right approach for different situations.

Market value simply reflects the current stock price multiplied by shares outstanding. It tells you what other investors think the company is worth right now based on supply, demand, sentiment, and speculation. Market value changes minute by minute as traders buy and sell. Unlike intrinsic value, market value makes no attempt to assess whether the price is reasonable given the business fundamentals.

Book value equals total assets minus total liabilities, representing the company's net worth on its balance sheet. This works well for banks and real estate companies where assets are relatively easy to value. But book value fails to capture intangible assets like brand reputation, patents, customer relationships, and the company's ability to generate future profits. A software company with minimal physical assets might have a low book value despite being highly valuable.

Price-to-earnings ratio (P/E ratio) is a quick valuation shortcut. Divide the stock price by earnings per share to see what multiple investors are paying for each dollar of profit. A P/E of 20 means investors pay $20 for every $1 of annual earnings. This makes comparisons easy, but P/E ratios ignore growth rates, debt levels, and cash flow quality. They also do not work for unprofitable companies.

Price-to-sales ratio (P/S ratio) divides market capitalization by total revenue. This helps value unprofitable but fast-growing companies like many startups. However, P/S ratios ignore profitability margins and capital requirements. A company with $100 million in revenue but $120 million in expenses might look cheap on a P/S basis while actually destroying value.

Intrinsic value stands apart because it focuses on the fundamental question: how much cash can this business generate for its owners over time? While other methods offer speed and simplicity, intrinsic value via DCF forces you to think carefully about the business's future and make explicit assumptions about growth, profitability, and risk. This deeper analysis often leads to better investment decisions.

Can Intrinsic Value be Negative?

Suppose your factory costs you more and more to run every year. Perhaps the price of cacao beans is going up by 20 percent per year, and you just cannot raise the price of your $2 bar every year to make up for it. Maybe your factory is slowly sinking into the mud, and you have to keep buying more concrete to keep it from turning into a sticky underground supervillain lair. At some point, your business may be generating less revenue than it takes to keep it running.

Sure, you could still liquidate the land and the factory and all the assets you have (those poor almond trees in the back and the coconuts taking up space on the shelves), but it is entirely possible that a few bad years in business could rack up enough debts that you will never be able to sell off everything and pay back the loans.

Intrinsic value calculations could keep potential investors from investing in your business then, and rightly so! This is especially important if you're on the investor side, considering whether to buy part of a business (or buy its stock)!

Use Intrinsic Value to Revise Your Investment Story

As with any financial ratio, the intrinsic value calculation tells part of a story. It can illuminate great opportunities, expose bad ones, and hide some details that you'll wish you had known. Be aware of its limitations, even as you use it to analyze potential stocks. When this number is out of line with everything else you're seeing, proceed with caution!

In general, a good company has a solid intrinsic value and a coherent plan to make more money year after year. In general, a company with a low intrinsic value—or a negative intrinsic value—may someday be a turnaround, but it's a risk. A startup which is spending lots of money to develop a product, find customers, or invent a market could have a negative intrinsic value for several years until its revenue accelerates. This isn't a bad situation. It's a common occurrence for a lot of startups. Yet it's also something you, as an investor, should take into account when you're deciding where to put your hard-won money.

Predicting the future is not easy, but good companies are good companies, and great managers want the same thing that we as stockholders and investors want: to produce more value every year. Focus on intrinsic value to help you decide the right price for a stock.

Learning More About Intrinsic Value

Benjamin Graham introduced intrinsic value and margin of safety concepts in his 1949 book The Intelligent Investor, which Warren Buffett called the best book about investing ever written. Graham's student Warren Buffett refined these ideas over decades, and his annual letters to Berkshire Hathaway shareholders provide real-world examples of intrinsic value thinking applied to actual investments.

For a deeper understanding of cash flow analysis, read about discounted cash flow and free cash flow. These concepts form the foundation of intrinsic value calculations. You can also explore present value to better understand how future dollars convert to today's values.

Remember that intrinsic value calculations serve as a tool for making better investment decisions, not as a precise prediction of what a stock will do tomorrow. Use these methods to think more carefully about business quality, growth potential, and appropriate prices. Over time, paying attention to intrinsic value can help you avoid overpriced stocks and identify genuine opportunities when great businesses go on sale.