The notion of intrinsic value has been around since at least Benjamin Graham -- 80 years running. The notion implies that an investment has innate, objective value that may or may not coincide with market value.
I've always been skeptical of this notion. When the term "intrinsic value" is conjured, it is conjured to support an analyst's target investment price, which more often than not differs from the market price.Somehow the aggregated opinions of buyers and sellers got it wrong, but the analyst gets it right. The market-formed opinion overlooks the investment's intrinsic value. But it won't indefinitely; eventually the market coalesces and intrinsic value and market value meld into one.
Actually, nothing is overlooked.The analyst offers only a subjective opinion of expected future value, not an irrefutable calculation of an intrinsic value. He or she can't, because there is no such thing. Value -- all value -- is subjective. If I were to give 10 analysts the same data, the same time, and have them independently calculate investment value, I assure you that I will get 10 different calculations.
Given Graham's considerable influence, it's no surprise my position has received considerable push back, but not persuasive push back. The push back materializes in various incarnations of the following theme: A company owns nothing but cash that divides into $6 per share.Cash is all the company is. There are no other assets and no liabilities. The company has cash assets of $6 a share, yet its shares trade at $5 each. Surely, the intrinsic value is $6 a share?
Things are much less sure. If each share were freely exchangeable for $6 (cash), shares would trade near $6 (slightly discounted for transaction costs). To trade $6 for $6 is no proof of intrinsic value. To say $6 is worth $6 is to say an identity. Besides, no one trades $6 for $6. It's not worth the effort to put your hand in your pocket to retrieve the six dollars.
Invariably, other variables come into play in the antagonist's argument: A degree of uncertainty exists, which accounts for the dollar discount.
For example, the company will pay all cash to shareholders upon the CEO's death, or the company has the right to invest the cash in certain risky assets. If that's the case, it is understandable that shares trade at $5 instead of the $6 per share.The former scenario accounts for the time value of money; the latter scenario demands a risk premium. Subjective opinions regarding desired discount rate or subjective opinions on the risk of investing cash intelligently come into play. Still, though, no intrinsic value. The CEO, the potential investments, the cash are all part of the package. Everyone subjectively forms an opinion on the outcome of the interplay of the three. There is nothing intrinsic about the value.
This all matters because the analyst isn't sufficiently forthright. The intelligent layman is lead to believe an intrinsic value exists where none does. An analyst states the intrinsic value of XYZ is $65 a share. Today, XYZ trades at $50. Sixty-five must reside in the future if it is the intrinsic value. This is misleading; $65 might never appear. But to the intelligent layman, it has to appear, or the word "intrinsic" has no meaning.
I've always been skeptical of this notion. When the term "intrinsic value" is conjured, it is conjured to support an analyst's target investment price, which more often than not differs from the market price.Somehow the aggregated opinions of buyers and sellers got it wrong, but the analyst gets it right. The market-formed opinion overlooks the investment's intrinsic value. But it won't indefinitely; eventually the market coalesces and intrinsic value and market value meld into one.
Actually, nothing is overlooked.The analyst offers only a subjective opinion of expected future value, not an irrefutable calculation of an intrinsic value. He or she can't, because there is no such thing. Value -- all value -- is subjective. If I were to give 10 analysts the same data, the same time, and have them independently calculate investment value, I assure you that I will get 10 different calculations.
Given Graham's considerable influence, it's no surprise my position has received considerable push back, but not persuasive push back. The push back materializes in various incarnations of the following theme: A company owns nothing but cash that divides into $6 per share.Cash is all the company is. There are no other assets and no liabilities. The company has cash assets of $6 a share, yet its shares trade at $5 each. Surely, the intrinsic value is $6 a share?
Things are much less sure. If each share were freely exchangeable for $6 (cash), shares would trade near $6 (slightly discounted for transaction costs). To trade $6 for $6 is no proof of intrinsic value. To say $6 is worth $6 is to say an identity. Besides, no one trades $6 for $6. It's not worth the effort to put your hand in your pocket to retrieve the six dollars.
Invariably, other variables come into play in the antagonist's argument: A degree of uncertainty exists, which accounts for the dollar discount.
For example, the company will pay all cash to shareholders upon the CEO's death, or the company has the right to invest the cash in certain risky assets. If that's the case, it is understandable that shares trade at $5 instead of the $6 per share.The former scenario accounts for the time value of money; the latter scenario demands a risk premium. Subjective opinions regarding desired discount rate or subjective opinions on the risk of investing cash intelligently come into play. Still, though, no intrinsic value. The CEO, the potential investments, the cash are all part of the package. Everyone subjectively forms an opinion on the outcome of the interplay of the three. There is nothing intrinsic about the value.
This all matters because the analyst isn't sufficiently forthright. The intelligent layman is lead to believe an intrinsic value exists where none does. An analyst states the intrinsic value of XYZ is $65 a share. Today, XYZ trades at $50. Sixty-five must reside in the future if it is the intrinsic value. This is misleading; $65 might never appear. But to the intelligent layman, it has to appear, or the word "intrinsic" has no meaning.
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