Glossary
Intrinsic value
The estimated true worth of a business from its fundamentals; for an option, the amount by which it is in the money.
Intrinsic value has two uses in finance. For a business or stock, it is an estimate of what the company is really worth based on the cash it can generate, independent of today's market price. For an option, it is a precise, mechanical figure: how much the option would be worth if exercised right now. Both answer the question "what is this worth apart from sentiment and time?"
Intrinsic value of an option
Intrinsic value of a business
Here the figure is an estimate, not a calculation with one right answer. The most common method is a discounted cash flow model: forecast free cash flow, discount it back at a rate reflecting risk, and add a terminal value. Small changes to inputs move the result a lot; raising the discount rate from 8% to 10% can cut a long-duration growth company's estimate by a quarter or more.
Value investors compare the estimate with the share price and look for a margin of safety, an idea associated with Benjamin Graham: buying only when the price sits well below the estimate, so errors in the forecast do not erase the case. Because two careful analysts can reach very different figures, intrinsic value is best treated as a range.