Friday, May 19, 2006

What is the intrinsic value of a golden tap?

The intrinsic value of a stock or an investment is its true or inherent value based on some valuation method and it is usually different from its market value.

Going back to my favourite analogy of the golden tap, I would like to ask this question: what is the intrinsic value of a golden tap? We know that the market value is S$1000, well because someone paid that much for it. But is that its true or intrinsic value? To calculate this, we make a few simple assumptions.

1) The golden tap used 28g or 1 ounce of gold
2) Manufacturing, processing cost is S$100 (10% of S$1000)
3) Price of gold at the time of purchase was US$600 (or S$960) per ounce

Adding up the no.s, we have S$100 + S$960 = S$1060, the intrinsic value of the golden tap according to my valuation method. So, our friend did not overpay for his golden tap.

In our example, intrinsic value = market value, but in reality that is rarely the case, more often than not, market value is greater than intrinsic value. For luxury goods, like a Prada bag, market value is probably 10-20 times more than its intrinsic value, in my opinion. (However, there are different valuation methods to derive at a product's intrinsic value. Perhaps a Prada bag owner's valuation method is something like: $10 cost of leather, $990 ability-to-show-the-world-I-own-a-Prada-bag).

The goal of investing, is to find an investment which has an intrinsic value significantly higher than its market value. This kind of investing is also known as value investing, pioneered by Benjamin Graham and David Dodd and later Warren Buffett, the world's most successful value investor.

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