This calculator employs the Gordon Growth Model (GGM) to estimate a company’s intrinsic value based on its expected cash flow, required rate of return, and long-term perpetual growth rate. It can also solve for any of the four core variables if the other three are provided.
Intrinsic Value Calculator
Intrinsic Value Calculator Formula
Based on the Gordon Growth Model (GGM):
$$IV = \frac{D_1}{r - g}$$
Formula Source: Investopedia: Gordon Growth Model | Corporate Finance Institute
Variables Explained
- Next Period FCF or Dividend ($D_1$): The expected cash flow per share the company will generate or pay out next year.
- Required Rate of Return ($r$): The minimum return an investor expects to receive, often derived from the CAPM (Capital Asset Pricing Model).
- Perpetual Growth Rate ($g$): The rate at which the company’s cash flows are expected to grow indefinitely. Must be less than $r$.
- Intrinsic Value (IV): The actual, underlying value of the stock, based on fundamental analysis.
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What is Intrinsic Value?
Intrinsic value is the calculated, objective worth of an asset, independent of its current market price. For stocks, it represents the present value of all future cash flows expected to be generated by the asset. When an investor finds a stock’s intrinsic value is significantly higher than its market price, the stock is considered undervalued and a potential buying opportunity.
The Gordon Growth Model (GGM) is a key technique used to find intrinsic value, especially for mature companies that pay consistent dividends or have stable free cash flow (FCF). It simplifies the long-term cash flow stream into a single number by assuming cash flows will grow at a constant rate forever.
It is a crucial tool for value investors, allowing them to compare the fundamental value against the market’s perception. The results are highly sensitive to the inputs, particularly the difference between the required rate of return ($r$) and the growth rate ($g$).
How to Calculate Intrinsic Value (Example)
Suppose Company A expects to pay a dividend of $1.50 next year ($D_1$). Your required rate of return ($r$) is 12%, and you estimate a perpetual growth rate ($g$) of 5%.
- Identify Variables: $D_1 = \$1.50$, $r = 12\% (0.12)$, $g = 5\% (0.05)$.
- Apply the Formula: $IV = \frac{D_1}{r – g}$.
- Calculate the Denominator: $r – g = 0.12 – 0.05 = 0.07$.
- Calculate Intrinsic Value: $IV = \frac{\$1.50}{0.07}$.
- Result: $IV \approx \$21.43$. The intrinsic value of the stock is estimated to be $21.43.
Frequently Asked Questions (FAQ)
Q: Why must the required rate ($r$) be greater than the growth rate ($g$)?
A: If $r$ were less than or equal to $g$, the denominator $(r-g)$ would be zero or negative, resulting in an infinite or negative intrinsic value, which is mathematically and economically nonsensical.
Q: Is this the only way to calculate intrinsic value?
A: No. The GGM is a simplification. Other common methods include the full multi-stage Discounted Cash Flow (DCF) model and various multiples-based approaches (e.g., P/E or P/S ratio comparisons).
Q: How do I estimate the Required Rate of Return ($r$)?
A: It’s often estimated using the Capital Asset Pricing Model (CAPM), which takes into account the risk-free rate, the equity market risk premium, and the stock’s beta.
Q: What happens if I input a market price for IV?
A: If you input the market price into the optional IV field, the calculator will perform a consistency check. If the calculated IV is close to the market price, the stock is fairly valued. If the calculated IV is higher, it is undervalued.