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How do you determine intrinsic value in a volatile market?

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Determining the intrinsic value of a company or an asset is one of the core skills of an investment banker. Intrinsic value is the present value of the future cash flows that the company or asset can generate, regardless of its market price. However, in a volatile market, where prices fluctuate rapidly and unpredictably, estimating intrinsic value can be challenging. How can you account for the uncertainty and risk that affect the cash flows and the discount rate? In this article, we will explore some of the methods and tools that you can use to determine intrinsic value in a volatile market.

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Adekunle kabir Awujoola, FCIB

Branch Manager at NIRSAL Microfinance Bank (Subsidiary of CBN)

1 Discounted Cash Flow

Discounted cash flow (DCF) is a widely used method to calculate intrinsic value. It involves projecting the future cash flows of the company or asset, and discounting them back to the present using a discount rate that reflects the risk and opportunity cost of investing. However, in a volatile market, both the cash flows and the discount rate can change significantly over time. To address this, you can use scenario analysis, sensitivity analysis, and Monte Carlo simulation to test how different assumptions and variables affect the intrinsic value.

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Adekunle kabir Awujoola, FCIB

Branch Manager at NIRSAL Microfinance Bank (Subsidiary of CBN)
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Intrinsic value in a volatile market can be determine using the DCF. This is the most commonly used method.It can be used by by projecting the future cashflows of an Asset or Company's by discounting them back to the present by using a discounted rate that shows the risk and the opportunity cost of investment. Sensitivity analysis, simulation of Monte Carlo, Scenario Analysis can be use to test the intrinsic value are affected by different assumptions and variables. The comparism of the company or asset with other asset of similar nature in the market can also be use to establish intrinsic value is Relate Valuation.

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2 Relative Valuation

Relative valuation is another common method to estimate intrinsic value. It involves comparing the company or asset to similar ones in the market, and using multiples or ratios to assess its value. For example, you can use the price-to-earnings (P/E) ratio, which measures how much the market is willing to pay for each unit of earnings. However, in a volatile market, the multiples or ratios can vary widely depending on the industry, the growth prospects, and the market sentiment. To address this, you can use a range of multiples or ratios, and adjust them for differences in quality, risk, and growth.

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3 Option Pricing

Option pricing is a more advanced method to value companies or assets that have embedded options or contingencies. An option is a right, but not an obligation, to buy or sell an underlying asset at a specified price and time. For example, a company may have an option to expand or abandon a project, or a convertible bond may have an option to convert into equity. In a volatile market, the value of these options can change significantly as the underlying asset price moves. To address this, you can use option pricing models, such as the Black-Scholes model or the binomial model, to estimate the value of the options and add them to the intrinsic value.

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4 Other Factors

In addition to the methods and tools mentioned above, there are other factors that can influence the intrinsic value of a company or asset in a volatile market. For example, you should consider the competitive advantage, the growth potential, the dividend policy, the capital structure, the governance, and the environmental, social, and governance (ESG) factors of the company or asset. These factors can affect the cash flows, the risk, and the market perception of the company or asset, and thus its intrinsic value.

Determining intrinsic value in a volatile market is not an exact science, but an art that requires judgment, creativity, and experience. As an investment banker, you should use a combination of methods and tools, and adjust them for the specific context and situation of the company or asset. By doing so, you can provide a more accurate and realistic estimate of the intrinsic value, and make better investment decisions.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How do you determine intrinsic value in a volatile market?

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1 Discounted Cash Flow

2 Relative Valuation

3 Option Pricing

4 Other Factors

5 Here’s what else to consider

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