So what does intrinsic mean?
If you see the term intrinsic definition, you’re almost certainly looking at the term for intrinsic value. The definition of intrinsic basically means the actual value of a company, stock, or other type of asset. You can think of intrinsic as the underlying value of something. This value isn’t as subject to the whims of markets and rapid developments.
In a perfect world where markets operated instantly and were always one hundred percent correct, the value of all stocks and other financial assets would be set at their intrinsic value. In the real world, however, things aren’t so simple.
Over time, markets will generally restore the value of something to its intrinsic value. During certain and often brief periods, however, the current price value of something might not correspond directly with its underlying intrinsic value. Markets are very effective in how they define values, but they are not perfect.
You might have also heard of extrinsic values. While intrinsic usually refers to the internal qualities of something, extrinsic refers to external values. The problem with external, extrinsic values is that outside factors can change quickly, making them less predictable.
Extrinsic Value Illustration
Let’s consider this example. Say, news breaks that a real estate developer is going to launch a huge development in the Hill Heights district of Hill City. Real estate values in Hill Heights will almost certainly begin to climb due to the external factors at play.
If the Hill Heights city council rejects the real estate developer’s proposal for development, however, the external factors will have instantly changed. Real estate values will go back to their normal, intrinsic values.
Extrinsic Values can Become Intrinsic Values
If the real estate developer’s plans go forward, the location of the real estate, which is a part of intrinsic value, will become the defining point of value for the real estate. In a sense, extrinsic values can, in some cases, become intrinsic values.
Value Investing: A Focus on Intrinsic Values
Value investors often focus on intrinsic value, and specifically finding companies that are currently undervalued. Warren Buffet made his many billions off of value investing and finding undervalued firms.
With value investing you basically look for the intrinsic values of various companies or other types of financial assets. You will then compare what you have determined to be the intrinsic value of the company to its current market value.
When you find companies which have an intrinsic value that is less than its current market value, you’ve found a company that is a good investment, at least from the point of view of a value investor. According to the basic tenets of value investing, the price of a stock or asset will eventually match or exceed its intrinsic value.
Often, temporary events can have a big impact on current market values. For example, if Big Box Store suffers a security breach and loses information regarding its customers, the company’s stock will likely suffer a temporary decline. Still, it’s unlikely that such an event will have a huge and lasting impact on the company’s intrinsic value. Most likely, stock prices will begin to rise after worries caused by the security breach dissipate.
So in short, you can think of intrinsic value as the “true” value of a company. This value won’t change as rapidly as market values, and stock prices will generally gravitate around it. Market prices will occasionally rise and fall above and below intrinsic values, but the intrinsic value will generally pull prices towards it. That’s how we define intrinsic. It’s a complicated term and concept, but one that every investor should at least be familiar with. If you’re still a bit confused, don’t worry, the definition itself can be a bit tricky for beginners.