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Intrinsic value is used to measure the true value of an investment, so it's important to understand the basics of investing. A company has two ways to raise money to run the business. They can issue stock or bonds. Companies issue common stock by selling ownership in the business. When you buy stock, you are an owner (investor) in the business. Your shares of stock represent a small percentage of ownership in the company. A bond represents a company debt. Investors who buy bonds are considered business creditors. The bond owner receives interest income on the bond investment, usually twice a year. The original amount invested is returned to the bond investor on the maturity date. Intrinsic value is based on the ability of a business to generate cash flow into the company and earn a profit. When a company's revenue (or sales) are higher than their expenses, the firm generates earnings. For this discussion, you can think of earnings and profit as the same thing. Companies must use cash to buy inventory, make payroll and advertise. That type of spending is considered a cash outflow. When customers pay for a product or service, the business has a cash inflow. The ability to generate more cash inflows than outflows over time indicates a valuable company. Investors have hundreds of investment choices. A bond investor, for example, expects a certain amount of interest income. A stock investor is interested in seeing the value of stock increase over time or in receiving a share of the earnings in the form of dividends. The intrinsic value formulas make assumptions about an investor's required rate of return You can think of this return as the investor's minimum expectation. If the investment cannot meet the expectation, it's assumed that an investor would not invest.
Look at your investment choices. Consider how a business becomes profitable. Choose an investment option.