For a long time, share price (or valuation) has been the number one way to determine business value. It is what investors have always sought to ensure their returns. However, share price can often be a less-than-ideal way to measure performance. Instead, business leaders should focus on intrinsic value. This is a sure way to delight investors in the long term.
Understanding Intrinsic Value
The key problem that comes with share price is that it is a market value. Thus, people are not only focused on the value of the business itself but also trying to estimate what others in the market are thinking and will do in the future. Thus, it is quite difficult to significantly outperform overall market trends.
A better way to approach your business’s value is to think about its fundamental worth. Intrinsic value is based on the projected value of future cash flows generated by business assets. In short, you should think about running a financially sound business rather than one optimized to generate a strong share price. In the long run, these two values will converge. However, you have much more direct control over intrinsic value than you do share price.
Calculating Intrinsic Value
The main challenge of using intrinsic value is that it is much harder to measure. It isn’t just a value you can look up on a spreadsheet. However, that does not mean it can’t be measured and managed.
There are a few different formulas you can apply to calculate this number. Indeed, the correct calculation depends on your unique situation. However, there are a few things you can think about to generate an appropriate scorecard for intrinsic value:
- Current Financials: How do your current balance sheet, income statement and cash flow statement look? What is your debt-to-income ratio?
- Investments: What investments is your business making to improve financials in the future? How are your current financials aligned with those investments? Are they realistic?
- Alignment: Does your overall business strategy align well with your goals? Is it aligned with broader changes in your market?
These questions can be converted into key performance indicators and scorecards. This will help you to develop a framework for thinking about your business with a focus on long-term value.
Start exploring this approach to your business value today. With these fundamental concepts in mind, you can begin building a healthier business that isn’t just focused on share price.