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Guide12 min read

How to Calculate Intrinsic Value of a Stock

Learn the step-by-step process for calculating a stock's intrinsic value using DCF, Graham Number, and PEG models. Includes formulas, examples, and common mistakes to avoid.

Meet Dhanani
By Meet Dhanani

Senior Software Engineer at Red Hat

Intrinsic value is the true worth of a stock based on its fundamentals, independent of what the market is currently charging. If you can estimate intrinsic value accurately, you can identify stocks trading below their worth and avoid overpaying for hype.

This guide walks you through three proven methods to calculate intrinsic value, with real formulas and practical examples.

What Is Intrinsic Value?

Intrinsic value represents what a business is actually worth based on its ability to generate cash flows, grow earnings, and create shareholder value over time. It’s the price a perfectly rational investor would pay if they had complete information about a company’s future.

The concept was pioneered by Benjamin Graham and David Dodd in their 1934 book Security Analysis and later popularized by Warren Buffett, who described intrinsic value as “the discounted value of the cash that can be taken out of a business during its remaining life.”

The key insight: market price and intrinsic value are different things. Markets are driven by emotion, momentum, and short-term thinking. Intrinsic value is driven by fundamentals.

Method 1: Discounted Cash Flow (DCF)

The DCF model is considered the gold standard of valuation because it values a company based on its future cash-generating ability, discounted back to today’s dollars.

The Formula

Intrinsic Value = Σ (FCF × (1 + g)^n) / (1 + r)^n + Terminal Value / (1 + r)^n

Where:

  • FCF = Free Cash Flow (current year)
  • g = Expected growth rate
  • n = Year number (1 through 10)
  • r = Discount rate (required rate of return)
  • Terminal Value = FCF in year 10 × (1 + terminal growth) / (r - terminal growth)

Step-by-Step Example

Let’s value a company with:

  • Current Free Cash Flow: $5 billion
  • Expected growth rate: 12% for years 1-5, 8% for years 6-10
  • Discount rate: 10%
  • Terminal growth rate: 3%
  • Shares outstanding: 1 billion

Step 1: Project free cash flow for 10 years, growing at the expected rate.

Step 2: Discount each year’s cash flow back to present value using the discount rate.

Step 3: Calculate the terminal value (the company’s value beyond year 10) and discount it.

Step 4: Sum all discounted cash flows + discounted terminal value.

Step 5: Divide by shares outstanding to get per-share intrinsic value.

When DCF Works Best

  • Companies with predictable, positive free cash flow
  • Mature businesses with stable growth patterns
  • Companies you plan to hold for 5+ years

When DCF Struggles

  • Pre-revenue or pre-profit companies
  • Highly cyclical businesses (oil, shipping)
  • Companies undergoing major transformation

Try it yourself with our DCF calculator. Input your own assumptions and see the result instantly.

Method 2: Graham Number

Benjamin Graham’s formula is designed for conservative value investors. It sets the maximum price you should pay for a stock based on two fundamental metrics: earnings per share and book value per share.

The Formula

Graham Number = √(22.5 × EPS × BVPS)

Where:

  • EPS = Earnings Per Share (trailing twelve months)
  • BVPS = Book Value Per Share
  • 22.5 = Graham’s constant (derived from P/E of 15 × P/B of 1.5)

Example Calculation

Company with:

  • EPS: $6.50
  • Book Value Per Share: $45.00

Graham Number = √(22.5 × 6.50 × 45.00) = √(6,581.25) = $81.13

If the stock trades at $65, it’s below the Graham Number, potentially undervalued by Graham’s standards.

Strengths and Limitations

Strengths:

  • Simple: only needs two inputs
  • Conservative: builds in a natural margin of safety
  • Time-tested: used successfully for decades

Limitations:

  • Ignores growth potential entirely
  • Doesn’t work for companies with negative earnings or book value
  • May undervalue high-growth technology companies

Calculate it instantly with our Graham Number calculator.

Method 3: PEG Ratio Valuation

The PEG ratio adjusts the P/E ratio for growth, making it useful for comparing companies growing at different rates.

The Formula

PEG Ratio = (Price / EPS) / Annual Earnings Growth Rate

A PEG of 1.0 means the stock is “fairly valued” relative to its growth. Below 1.0 suggests undervaluation; above 2.0 suggests overvaluation.

Deriving Fair Value from PEG

To find fair value using PEG:

Fair Value = EPS × Growth Rate × Fair PEG (1.0)

Example:

  • EPS: $4.00
  • Growth Rate: 20%
  • Fair PEG: 1.0

Fair Value = $4.00 × 20 = $80.00

If the stock trades at $60, the PEG model suggests it’s undervalued.

When PEG Works Best

  • Comparing growth stocks to each other
  • Technology and healthcare sectors
  • Companies with consistent earnings growth

Try our PEG ratio calculator to analyze any stock.

Combining Multiple Models

No single model captures the full picture. Professional analysts use multiple methods and weight the results:

Model Best For Weight (Typical)
DCF Cash-flow-positive companies 40%
Graham Number Value stocks, financials 25%
PEG Ratio Growth stocks 25%
Dividend Discount Dividend payers 10%

Our intrinsic value calculator automatically blends all four models into a composite estimate.

Common Mistakes to Avoid

  1. Using overly optimistic growth rates: If a company grew 30% last year, don’t assume that continues for a decade. Mean reversion is real.

  2. Ignoring the discount rate: A higher discount rate dramatically reduces intrinsic value. Use 10% as a baseline for most stocks; 8% for stable blue chips; 12%+ for risky small caps.

  3. Forgetting about dilution: Stock-based compensation creates new shares. Use diluted share count, not basic.

  4. Anchoring to market price: Calculate intrinsic value before looking at the current stock price. Otherwise you’ll unconsciously bias your assumptions.

  5. Not applying a margin of safety: Even the best model has uncertainty. Apply a 20-30% margin of safety before buying. Use our margin of safety calculator to determine your buffer.

Putting It All Together

The process for any stock:

  1. Gather financial data (EPS, free cash flow, book value, growth rate)
  2. Run at least two valuation models
  3. Average or weight the results
  4. Apply a margin of safety (20-30% below intrinsic value)
  5. Compare to current market price
  6. If market price < intrinsic value minus margin of safety → potential buy

Browse our stock fair value estimates to see this process applied daily to 140+ US stocks with real financial data.

Try It Yourself

Put this knowledge into practice with our free calculators:

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