The Intrinsic value of a Stock

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Video Transcription:

Hello traders, welcome to the stock trading course and the sixth module: investing, stock picking.

In this lesson we’re going to learn how to determine a stock’s intrinsic value. And to do so we are going to use the Gordon Growth Model. And we are going to use it to calculate the fair value of a stock today. This model is based on the stock’s expected future dividends. This is why this model is more effective with a large company on mature markets.

So let’s continue with the Gordon Growth Model. This model is used by analysts and investors to compare the predicted stock value against the actual market price. Investors view the difference in the two values as evidence that the stock might be undervalued or overvalued. This method for calculating the intrinsic value of a stock today should be used along with a full analysis methodology to decide on an investment. Remember that calculating the fair value of a stock today can be subjective. And this is why this model is best used with a complete valuation analysis of a company. Of course, by calculating the fair value of the stock price with Gordon Growth Model you are going to get an idea of if the stock is really underpriced or overpriced.

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So the formula is P equals D one divided by K minus G, where P is the stock value based on model, D one is the expected dividend per share on one year from now, K is the required rate of return for investor, and G is the growth rate in dividends. So let’s go through an example.

Let’s take company ABC. And its stock is traded today at $20.85. The company pays $1.15 dividend per share. And the company predicts its dividends will steadily grow by 5% per year. And the investors require rate of return is 9%. And remember that the required rate of return, or triple R, is the minimum annual percentage earned by an investment that will in due… [Audio skips]

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Investors to put money into a company. And these investors’ required rate of return can vary from investor to investor. So if we calculate the fair price of the company, by using the Gordon Growth Model, we get a price of $28.75. According to the Gordon Growth Model the stock is worth $28.75. That’s $7.90 more than the actual market price. According to the model the stock might be undervalued and might be a good buy option. So as you can see this calculation can be subjective but it will show you or compliment the analysis that you with the financial performer’s ratios, the financial health ratios and the valuation ratios.

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