Value = Σ FCFₜ ÷ (1 + WACC)ᵗ + Terminal ValueThe point of comparing price with value is to spot obvious gaps — not to manufacture false precision.
How to Calculate Intrinsic Value
A step-by-step method for estimating what a business is actually worth — ending in a defensible range, not a false-precision number. Educational content only.
What you are actually estimating
Intrinsic value is the present value of all cash a business will hand its owners over its lifetime. The market price is what someone will pay today; intrinsic value is your independent estimate of what the thing is worth. The entire discipline of value investing lives in the gap between the two.
Because the future is uncertain, intrinsic value is always an estimate conditional on assumptions. The goal of this guide is not a magic formula — it is a process that makes your assumptions explicit, testable, and improvable.
The step-by-step method
- Understand the business first. Read the latest annual report. If you cannot explain how the company makes money in two sentences, stop here — valuation built on confusion is decoration.
- Establish normalized owner earnings. Start from free cash flow or net income, strip out one-time items, and adjust for the capital spending truly needed to maintain the business.
- Choose a growth assumption you can defend. Look at the past decade's growth, the industry trajectory, and reinvestment capacity. Write down WHY you chose the number, not just the number.
- Discount the future cash flows. Apply a required rate of return (many practitioners use 9–12%) to the forecast years plus a conservative terminal value. This is the DCF engine — see the dedicated guide.
- Express the result as a range. Run the model with pessimistic, base, and optimistic inputs. The honest answer is "roughly $X to $Y per share", never "$X.42".
- Compare with the price and demand a margin of safety. Only when the market price sits well below the low end of your range does the estimate become actionable research.
Common mistakes
- Anchoring growth assumptions to the current stock price instead of business fundamentals.
- Using a single-point output instead of a range with sensitivity analysis.
- Forgetting that terminal value usually dominates the result — and deserves the most suspicion.
- Valuing a business you do not understand: garbage in, precise-looking garbage out.
- Skipping the written record. Undocumented assumptions cannot be reviewed or improved.
- 1What you are actually estimating
- 2The step-by-step method
- 3Common mistakes
| Shortcut | A step-by-step method for estimating what a business is actually worth — ending in a defensible range, not a false-precision number. Educational content only. |
|---|---|
| Disciplined workflow | What you are actually estimating → The step-by-step method → Common mistakes |
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True story · Washington Post, 1973
You don't need a scale to know a man is fat
In the brutal 1973–74 bear market, the entire Washington Post Company — the newspaper, Newsweek magazine and several TV stations — traded for around $100 million. Buffett conservatively reckoned the assets were worth at least $400 million. No precise model was needed: the gap between price and value was visible from across the street.
He invested about $10.6 million, then watched the stock fall further and did nothing but wait. Decades later the position was worth more than $1 billion, plus a stream of dividends along the way — a return of roughly one hundred times. As Buffett put it: you don't need to know a man's exact weight to know that he's fat.
The point of comparing price with value is to spot obvious gaps — not to manufacture false precision.
≈$10.6Minvested in 1973
4×assets vs market price
≈100×over three decades
True story · PetroChina, 2003
A valuation done with an annual report and a weekend
Buffett read PetroChina's annual report at home and pegged the company's value at roughly $100 billion. The market was pricing it near $37 billion. He built no spreadsheet, met no management, sought no second opinion — the gap was too wide to need precision. Berkshire bought about $488 million of the Hong Kong-listed shares.
By 2007, rising oil prices and a re-rating had carried PetroChina's market value past $250 billion. Buffett sold the entire stake for about $4 billion — roughly an eight-fold return plus dividends — and moved on.
When value is triple the price, ordinary accuracy is enough. The best decisions rarely require the most elaborate models.
$37B vs $100Bprice vs estimated value
≈$488Minvested in 2003
≈8×realized by 2007
True story · Benjamin Graham
The exception that beat all the rules
In 1948, Graham-Newman put about $712,000 — close to a quarter of the fund — into GEICO, an insurer that sold directly to careful drivers by mail and skipped the agent entirely. The position broke Graham's own diversification rules, and regulators even forced the fund to distribute the shares to its investors.
Those who kept the shares watched them grow more than two hundred-fold. Graham, the great apostle of wide diversification and statistical bargains, admitted in his memoirs that this single decision earned more than all the profits from twenty years of his diversified operations combined.
Even the father of quantitative bargains conceded: one outstanding business, deeply understood, can outweigh a career of small edges.
$712Kinvested in 1948
200×+growth of the stake
≈25%of the fund in one stock
Related tools
Frequently asked questions
Which earnings figure should I start from?
Owner earnings or normalized free cash flow are the most honest bases. Reported net income can be distorted by accounting choices and one-time items.
How accurate can an intrinsic value estimate be?
Never precise — usefully approximate at best. The aim is to be roughly right with a margin of safety, not exactly right without one.
Is this a buy signal when price is below value?
No. It is a research finding that justifies deeper work. This guide is educational and not investment advice.
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