What is Intrinsic Value?

//What is Intrinsic Value?
What is Intrinsic Value? 2017-10-05T03:45:39+00:00

Definition: Intrinsic value is the inherent worth of a company, investment, or asset based on its fundamental characteristics and earning power.

What Does Intrinsic Value Mean?

What is the definition of intrinsic value? The inherent value can be applied to stocks, bonds, and whole businesses. Many investors apply this concept to options by stating that the value of an option is the profit that the option holder will realize if the option is exercised immediately.

Value investors who look for undervalued shares to make a profit use this idea in their business. Generally, the inherent value of an investment vehicle is different than the fair value. Therefore, value investors buy stocks or call options, expecting that the market price will rise above the inherent value so that they can sell the stock or the call optionand realize a profit.

Also, the inherent value takes into account the value of the intangible assets of a firm, such as technology, patents, trademarks and so on. Although it is impossible to predict the factor that may have a negative impact on a stock, the rule of thumb is that companies with a lot of intangible assets portray significant differences between their market price and their inherent value.

Let’s look at an example.

Example

Alex holds 100 shares of a leading retailing company, which currently trade at $90. The company has acquired a second plant and has introduced a new product. So, Alex buys a call option for $3 at a strike price of $70. Given that each option contract covers 100 shares, Alex pays a total of $300 for the shares he owns to acquire the call option.

If Alex exercises the call option immediately, he will earn:

Current price – strike price = $90 – $ 70 = $20 per share x 100 = $2,000 – $300 = $1,700. So, the intrinsic value of the call option is $20.

If Alex waits for the stock price to rise at rises at $105, he will exercise the call option by buying 100 shares for $90 ($9,000) to sell them for $100 on the open market ($10,500). In this case, his profit is $10,500 – $9,000 = $1,500 – $300 = $1,200.

Generally, the higher the intrinsic value of an option, the lower the possibility that the option will not be exercised immediately.

Summary Definition

Define Intrinsically Valued: Intrinsic value means an inherent quality in a good, service, or business that makes it worth something.