I'm often asked how to find the intrinsic value of a stock, how does Warren Buffett $BRK.B find the intrinsic value of a stock.
First, we need to understand that the intrinsic value of a stock and the intrinsic value of a company are the same since buying one share, means you're an owner of the company.
In the past, to calculate the intrinsic value of a company, you could have looked at the book value but today, this is no longer possible since many companies have their assets in brand value and other intangibles. For example, most of Apple $AAPL asset is in the brand.
Warren Buffett calculates the intrinsic value of a stock by looking at it as a bond. It is easy to find the present value of any bond. You just need to know the maturity, the par value and the coupon rate. From this we calculate the total cash flow of the bond and then we have to use a discount rate (because money today has more value than money in the future) and we can find the intrinsic value of the bond. We can do the same thing if we look at stocks as bonds.
For Warren Buffett, the cash flow of a stock is the owner's earnings. The owner's earnings is calculated by adding to the net income, amortization, depreciation and depletion then subtract the maintenance capital expenditures.
The company can use the owner's earnings to do three things: reinvest in the business for growth (eventually, this will lead to capital gain), pay dividends or buyback shares.
You still need to discount the future and you discount (at a proper discount rate) all the future owner's earnings of the company to find the intrinsic value. Also only buy the company using a margin of safety.
The limitations of this method (also commonly known as discounted free cash flow method) is that only a small change in the terminal growth rate or discount rate can make a big difference in the intrinsic value and it makes most sense if you're going to hold the company forever.
Therefore, depending on the company, I use an appropriate earnings multiple. For example, with GameStop $GME , since things are moving very rapidly, I will look at the next 2 years but with JPMorgan Chase $JPM , I will even consider 10-20 years.
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