by The Graham Investor on June 10, 2009

T he word intrinsic comes from the latin intrinsecus meaning inward. In modern parlance, intrinsic means belonging to a thing by its very nature. The intrinsic value of a stock will thus be very personal to that stock, unique even, and will be totally unrelated to the intrinsic value of another stock. In a sense, intrinsic valuation is the art (and possibly science, depending on how analytic we are) of putting a fair value on current, and more often future returns.  It is a very useful tool, and one every value investor should use.

The asset base of a company is a baseline for intrinsic value; on top of that, measured value comes from returns what the company is doing and is likely to do with that asset base. Intrinsic valuation requires quite a few assumptions, and is never precise projected values can be vastly different from what is expected.

On our intrinsic value screen, we use the expected growth rate for the next 5 years; how the intrinsic value is calculated is mentioned here :

Calculating intrinsic value for a stock allows us to assess future returns and risk. The value will tell us if the expected growth is sustainable; for example Tidewater (TDW) is showing an intrinsic value of $518, with the current price at $50.18. The 5 year growth is expected to be 57% according to analyst estimates, while the industry rate is expected to be around 12% over the same period. Looking at a long-term chart of Tidewater since 1980, the highest price it reached was $71.

So, we have to ask is $518 a realistic price for TDW? But what we should be asking is: is 57% a realistic growth rate for the next 5 years? Doubtful.

In other words, we should use the intrinsic value calculation as a reality check while we ask lots of questions how much growth will this company *really* see? How soon will it happen (whats our timeframe)? How long will the company maintain the growth? Sometimes less is moremore companies can sustain lower growth rates for a longer time. These types of companies are valuable.

We also want to look for consistency in growth, not companies that engage in boom and bust growth, i.e. a smooth exponential upward curve in growth. If you find one, hang onto it.

In summary, do not use intrinsic value alone to buy stocks, but use it as a stock tool for sanity checks in your value investing toolbox.