CHAPTER 4How to Think About a Security’s Intrinsic Value

In Chapter 1 we show how to value an asset using a discounted cash flow model and in Chapter 2 we use these tools to value a simple business. In Chapter 3 we show how to evaluate a company’s competitive advantage to properly value growth. We finish that discussion by converting the resulting business value to a single point estimate. At the risk of confusing the reader, we will show in this chapter that it is unrealistic to assume that one can derive a single-point estimate of value. Rather, it is better to think of a company’s intrinsic value as a range of values. However, we need to define intrinsic value before proceeding.

What is “Intrinsic Value”?

One might ask: “Isn’t the definition of intrinsic value simply the value of the business?” Yes and no. While Benjamin Graham and David Dodd introduce the term intrinsic value in their seminal work Security Analysis, first published in 1934, surprisingly, the authors never provide a specific definition.

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Rather, they discuss the concept in more general terms. For instance, the first1 mention of the phrase intrinsic value appears on page 16:

[In 1922] Wright Aeronautical Corporation stock was selling on the New York Stock Exchange at only $8, although it was paying a $1 dividend, had for some time been earning over $2 a share, and showed more than $8 per share in cash ...

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