Where is the Value of Intrinsic Value?

This write-up is credited to Blue who requested for it. :)

Before I begin, allow me to do a little background.
There are 3 major schools of investing:
1) Fundamental Analysis
2) Technical Analysis
3) Efficient Market Theory


Fundamentalist has long advocate that any purchase of securities (stock) should be based on its intrinsic value, or the true value of the company.

According to Investopedia, intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. Value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.

Note the following:
1) Investopedia says, may or may not be the same as current market value, i.e. share price. Fusion Trader says, it will NOT be the market value. Market moves in accordance to the Supply and Demand. Not based on true value perception.

2) Investopedia says, it is based on the perception of its true value including all aspects of the business, in terms of both tangible and intangible factors.
Fusion Trader says, "Great definition. How are we to value these intangibles?"
Terminology: Tangibles are those with physical form. This would include assets such as Machinery, etc. Intangibles are those with no physical form. This would include assets such as Brandname, etc.
3) Investopedia says, value investors use a variety of analytical techniques in order to estimate the intrinsic value of securities in hopes of finding investments where the true value of the investment exceeds its current market value.
Fusion Trader says, "Would like to highlight the words - estimate and hopes."


Let's proceed to the many valuation models which could be used to estimate the intrinsic value. The list is not exhaustive.

1) NTA plus
NTA or Net Tangible Assets measures the balance tangible value of the company. Its main use is for safety reasons. It does not measure Intangibles, hence does not fully measure the intrinsic value. The idea is this:
Say, Company A is trading at 2.00 per share.
NTA is 2.50.
Undervalued. Buy.
Logic: Company's NTA is 2.50. And that is without the intangibles! Surely, if the intangibles are accounted for, it would be worth more than 2.50!!! What's more, the share price is only at 2.00!!! What a superb bargain!!!
Problem with Logic: Market is not based on Logic. It is based on Supply and Demand.
Problem with Approach: A self fulfilling prophecy. If all the market players uses this approach to invest in the stock market, it will work. If none uses this approach, it will stay as a "hidden gem" forever.

On another note. Some may think that should this company decides to close its operation, would it be an instant 0.50 profit? You bought it at 2.00 while the the NTA is 2.50.
Logically, the NTA means after liquidating all the assets and repaying all the liabilities, there should be a 2.50 per share sitting around to be distributed to its shareholders. So, if you bought it at 2.00, it wouldn't it be an instant 0.50 profit?

Sadly, I would have to burst your bubble. NTA is not NRV. NRV is the Net Realisable Value.
NTA is based on historical cost. Simply said, it means the cost of which it was acquired.
NRV is based on realisable value. Simply said, it means what you could sell it for.
Notice the difference?


2) Capital Asset Pricing Model (CAPM)
Investopedia says, it is model that describes the relationship between risk and expected return and that is used in the pricing of risky securities.
Its formula:


OK, you lost me :P.


3) Modigliani & Miller (M&M)
Investopedia says, it is a financial theory stating that the market value of a firm is determined by its earning power and the risk of its underlying assets, and is independent of the way it chooses to finance its investments or distribute dividends. Remember, a firm can choose between three methods of financing: issuing shares, borrowing or spending profits (as opposed to dispersing them to shareholders in dividends). The theorem gets much more complicated, but the basic idea is that, under certain assumptions, it makes no difference whether a firm finances itself with debt or equity.
Fusion Trader says, "Can't wait for it to get more complicated" :P


4) Black Scholes Model
For options, many experts, e.g. Alan Voon, the Malaysian Warrants Specialist, uses this model.

Investopedia says, it is a model of price variation over time of financial instruments such as stocks that can, among other things, be used to determine the price of a European call option. The model assumes that the price of heavily traded assets follow a geometric Brownian motion with constant drift and volatility. When applied to a stock option, the model incorporates the constant price variation of the stock, the time value of money, the option's strike price and the time to the option's expiry.
Also known as the Black-Scholes-Merton Model.
Fusion Trader says, I have the formula in my ACCA textbooks, but I seriously doubt anyone would be interested into it. The basic idea is good. However, too many subjectivity is involved.
For those who are interested, you can always refer to Mr Alan Voon. I think he wrote an article about this in his site - http://www.warrants.com.my/


If you don't understand what has been transpired so far, I congratulate you.
This is my whole point. I do not see the value of intrinsic value.
While many advocate looking for "hidden gems", I do not advise so.
I understand that my believe in this is radical to many traditional investing views.
It would be a direct contradiction to Benjamin Graham, the father of Fundamental Analysis.

However, let me ask you a question,
"Was Warren Buffett, the World's Greatest Investor, the student of Benjamin Graham?"
"Who was more successful, Benjamin Graham or Warren Buffett?"
"Are their approach 100% the same?"

I am neither advising against using Fundamental Analysis, nor am I discrediting it.
To me, Fundamental Analysis is merely an additional tool. It tells us WHY should we buy.
I would rather use another approach - Technical Analysis to tell me WHEN to buy.

PS: Fusion Trader is an accountant, an investor and a trader. His views are formed based on his accounting knowledge, market knowledge and personal experience. His views may or may not be accurate. However, he speaks freely and candidly on his opinions. Feedbacks are always welcomed, irrespective of whether it is positive or negative in nature. Thank you.