How are book value and intrinsic value different?

Book value and intrinsic value are two ways of measuring the value of a business. There are a number of differences between them, but book value is essentially a measure of the present, while intrinsic value takes into account estimates for the future.

What is book value?

Book value is based on the value of total assets minus the value of total liabilities – it attempts to measure the net assets that a business has accumulated so far. In theory, this is the amount that shareholders would receive in the event of a total liquidation of the company.

For example, if a business has assets of $ 23.2 billion and liabilities of $ 19.3 billion, the book value of the business would be the difference, which is $ 3.9 billion. To express this number in terms of book value per share, just take the book value and divide it by the number of shares outstanding. If a particular company is currently trading below its book value, it is often considered undervalued.

However, there are several issues with using book value as a measure of value. For example, the value the company would receive in a liquidation would be unlikely to equal the book value per share. Nonetheless, it can still be used as a useful benchmark to estimate how much a profitable company’s shares might fall if the market turns sour.

What is intrinsic value?

Intrinsic value is a measure of value based on the future profits a business is expected to generate for its investors – it attempts to measure the total net assets that a business is expected to build in the future. It is considered the true value of the business from an investment perspective and is calculated by taking the present value of the profits (attributable to investors) that a business is expected to generate in the future, as well as the value of future sale of the business.

The idea behind this measure is that buying a stock entitles the owner to his or her share of the company’s future profits. If all future profits are known with precision along with the final selling price, the true value of the business can be calculated.

For example, if we assume that a business will exist for a year and generate $ 1,000 before being sold for $ 10,000, we can find the intrinsic value of the business. By the end of the year, we will have received $ 11,000. If our required rate of return is 10%, then the present value of future earnings and the sale price is $ 10,000. If we were to pay more than $ 10,000 for the business, our required rate of return would not be met.

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