what is intrinsic and extrinsic value?

Intrinsic and Extrinsic value are terms you may hear when someone is talking about the value of an asset. They are crucial things to know to understand the value structure of our financial markets. Here we will go in detail on what these actually mean.

Intrinsic Value

Intrinsic value is the true, inherent worth of something, based on its essential qualities. In the world of investing, it means the actual value of a stock, company, or asset based on fundamental analysis.

How to Determine Intrinsic Value:

Fundamentals: This includes the company's earnings, revenue, cash flow, and growth potential.

Discounted Cash Flow (DCF): This method involves predicting the company’s future cash flows and discounting them to present value.

Assets and Liabilities: Evaluating what the company owns and owes helps in determining its intrinsic value.

Example: If a company’s stock is priced at $50, but based on its earnings, growth, and assets, you calculate its intrinsic value to be $70, the stock is undervalued and might be a good investment.

Extrinsic Value

Extrinsic value is the additional value of an asset that is not based on its intrinsic qualities but on external factors.

Types of Extrinsic Value:

Market Sentiment: How people feel about the stock or market can affect its price. If a stock is hyped up by news or social media, its price might go up even if its intrinsic value hasn’t changed.

Time Value: For options, the extrinsic value includes the time left until the option expires. The longer the time, the higher the extrinsic value. You will learn more about this in our next blog post.

Supply and Demand: If more people want to buy a stock, its price can go up, regardless of its intrinsic value.

Example: A new tech gadget might be priced higher because it’s trendy and in demand, even if its intrinsic value based on materials and production costs is lower.

Comparing Intrinsic and Extrinsic Value

Intrinsic Value: Focuses on fundamental qualities and actual worth.

Extrinsic Value: Influenced by external factors like market sentiment, time, and demand.

Why It Matters in Investing

Understanding both intrinsic and extrinsic value helps investors make better decisions. If you know a stock's intrinsic value, you can spot undervalued or overvalued stocks. Recognizing extrinsic factors helps you understand market movements and avoid hype-driven investments.

Example: Suppose a stock is trading at $100. If its intrinsic value is $80, but it’s being hyped up on social media, that extra $20 is extrinsic value. As an investor, knowing this helps you decide whether to invest based on fundamentals or avoid it due to hype.

Conclusion:

In summary, intrinsic value is about the true worth based on real data, while extrinsic value is about the external influences that affect an asset’s price. Knowing the difference helps you make smarter investment choices. Good luck teenagetraders!