The ultimate goal of fundamental analysis is to find an
asset’s intrinsic value. Investors analyze a stock’s intrinsic value along with
its current market value to determine what to do with that stock.
However, not everybody is familiar with fundamental
analysis. And some of them are already doing some fundamental analysis without
them knowing it. Some choose technical analysis.
In this article, we’ll discuss the most important concept in
fundamental analysis.
What it Intrinsic Value?
When we say intrinsic value, we are simply referring to a
company’s stocks’ actual value.
To find the intrinsic value of a stock or a business, you
have to consider all the aspects of the industry under which it belongs. And those aspects include both
tangible and intangible factors that may directly and indirectly a business.
Now, it is important to remember that an asset’s intrinsic
value may not be the same as its current market value. Generally, if the intrinsic
value of an asset is greater than its current market value, then it’s
considered undervalued. On the flip side, if its intrinsic value is lower than
its current market price, it’s considered to be overvalued.
Fundamental analysts usually consider both qualitative and
quantitative factors. They do that to find out the current health of the company—whether
it’s worth more than how the overall market sees it.
Intrinsic Values for Options Trading
Investors also typically want to know a company’s intrinsic
value for determining the best course of action for call options or options trading.
The intrinsic value for call options refers to the
difference between the price of the underlying price and the strike price. The strike
price is the predetermined price at which a call option can be executed. For put
options, the intrinsic price refers to the difference between the strike price
and price of the underlying stock’s price.
The intrinsic value of the option is considered zero if the
resulting difference falls into the negative territory. To make up the total
value of the option’s price, you have to combine the extrinsic and the
intrinsic values.
Extrinsic Value
The extrinsic value is also known as time value. This is because
one of the primary factors that affect the option premium is the time left
before the option contract expires. Generally, the contracts shed some of its values
as the expiration nears.
Another factor that affects the extrinsic value is the
implied volatility, which measures the amount of volatility as asset possesses
during a certain period. This is
obtained based on the current market prices. If the implied volatility rises,
the extrinsic value will also increase.
Intrinsic Value vs. Market Value
It is important to know the asset’s current market value if
you want to come up with an accurate estimate of its intrinsic value.
Intrinsic values and market values have many differences.
Market value refers to the price at which the asset can be bought
from the marketplace. The market value can also be referred to as the company’s
market capitalization. You can obtain it by multiplying number of its
outstanding shares with the current share price.
Because their market prices are easily obtainable,
exchange-traded instruments, like stocks and futures, have market values that are
very easily to calculate. On the other hand, instruments traded at the OTC
markets, like fixed income securities, are a bit more challenging to compute.
The biggest challenge you will face in determining the market
value of a company is the estimation of illiquid assets, such as real estate
and businesses. You may need to hire the service of real estate appraisers and
business valuation experts.
Conclusion
Fundamental analysis entails the study of in-depth and
organized values that have bearings in the market performance of an asset. It will
be very helpful for you if you also study the quantitative and qualitative factors
that affect an asset’s intrinsic and market value.
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