When evaluating a stock, one of the most critical concepts is its intrinsic value — essentially the true worth of a company, as perceived by an analyst. If a stock's market price is lower than its intrinsic value, the company is considered undervalued, signaling a potential buying opportunity.
Conversely, a stock trading above its intrinsic value is deemed overvalued, which could signal it’s time to exit. Intrinsic value helps investors decide when to enter or exit a position, guiding them on whether the stock is a good deal or overpriced.
But how do we calculate this intrinsic value? Let's take Reliance Industries (NS:RELI) as an example. Currently, the stock trades at INR 2,906. To determine its true worth, various complex financial calculations are necessary. These calculations, known as financial models, consider multiple assumptions and datasets. However, manual calculations can be time-consuming and complex.
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That’s where InvestingPro+ comes in. This tool simplifies the process by calculating Reliance Industries’ intrinsic value using 14 different financial models, such as the 5-year DCF (Discounted Cash Flow), P/E (Price-to-Earnings) multiple, and EV/EBIT (Enterprise Value to Earnings Before Interest and Taxes), among others. These models provide a range of projected intrinsic values based on their specific parameters and datasets.
With multiple models offering different values, the question becomes: which one should you trust? A good approach is to take the average of all the values. This results in a more rounded and realistic estimate, which is what InvestingPro+ refers to as the “Fair Value.”
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For Reliance Industries, the fair value is estimated at INR 2,734.5, while the stock is currently trading at INR 2,906. This suggests the stock is slightly overvalued, with a potential downside of around 6% before it aligns with its fair value.
By using the fair value metric, investors can track their portfolios and identify overvalued stocks before a price correction hits, preventing losses. Similarly, the fair value can help investors spot undervalued stocks with room for growth, aiding in making buy or hold decisions.
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