Intrinsic Value & Book Value - Concept Checker

​
​

Intrinsic or fundamental value is the perceived value of an investment's future cash flows, expected growth, and risk. The goal of the value investor is to purchase assets at prices lower than the intrinsic or fundamental value.

​ ​

Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.

The calculation of intrinsic value, though, is not so simple.  Intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Book value, an easily calculable number, though one of limited use.

​ 

The book value of an entity is an accountant's view of the value of the company. The book value could be the intrinsic or fundamental value if you believe the accountants' estimate of assets and liabilities are the true value and there are not intangible values to be considered. But accounting methodology makes it rare that the book value would be a good indication of the real or fundamental value.

You can gain some insight into the differences between book value and intrinsic value by looking at one form of investment, a college education. Think of the education's cost as its "book value." If this cost is to be accurate, it should include the earnings that were foregone by the student because he chose college rather than a job.

For this exercise, we will ignore the important non-economic benefits of an education and focus strictly on its economic value. First, we must estimate the earnings that the graduate will receive over his lifetime and subtract from that figure an estimate of what he would have earned had he lacked his education. That gives us an excess earnings figure, which must then be discounted, at an appropriate interest rate, back to graduation day. The

rupee​

 result equals the intrinsic economic value of the education.

Some graduates will find that the book value of their education exceeds its intrinsic value, which means that whoever paid for the education didn't get his money's worth. In other cases, the intrinsic value of an education will far exceed its book value, a result that proves capital was wisely deployed. In all cases, what is clear is that book value is meaningless as an indicator of intrinsic value.