Learn DCF basics, P/E-based valuation, the Graham Number, and the all-important margin of safety.
In this lesson you'll learn
What intrinsic value means and why it matters
P/E-based valuation: the simplest method
DCF (Discounted Cash Flow): the gold standard
The Graham Number for defensive value investors
EV/EBITDA for comparing company values
Why the margin of safety is your best protection
What is intrinsic value?
Intrinsic value is what a business is fundamentally worth — based on its actual cash flows, assets, and earnings power — independent of what the market is currently pricing it at.
The market price and intrinsic value are not the same thing. The market is a voting machine in the short term (driven by emotion, sentiment, momentum) but a weighing machine in the long term (driven by fundamentals). Benjamin Graham — Warren Buffett's mentor — made this observation in 1934, and it's still true today.
Market Price vs Intrinsic Value over time
Overvalued (avoid or sell)
Price90
Value60
Market paying too much. Future returns likely disappointing.
Fairly Valued (hold)
Price65
Value60
Price ≈ value. Reasonable to hold if you own it.
Undervalued (opportunity)
Price45
Value60
Market pricing the stock below its worth. Potential buying opportunity.
Find the company's current EPS (earnings per share)
Research the sector's average historical P/E (e.g. consumer staples ~18×, tech ~28×)
Multiply: Estimated Intrinsic Value = EPS × 'Fair' P/E
Compare to today's stock price
EXAMPLE
A bank earns $5 EPS. Banks historically trade at ~12× P/E. Fair value estimate: $5 × 12 = $60. If the stock trades at $48, it may be undervalued (20% margin of safety).
⚠ Limits:Only works for profitable companies. P/E is backward-looking; forward earnings estimates may differ significantly.
Apply a 'discount rate' (usually 8–12%) — reflects that future money is worth less than today's money
Calculate the 'terminal value' (what the business is worth after your forecast period)
Sum all discounted cash flows → intrinsic value
EXAMPLE
If a company generates $100M FCF, growing 15%/year, discounted at 10%, the DCF might yield an intrinsic value of $1.8B. If market cap is $1.2B, it's trading at a 33% discount.
⚠ Limits:Highly sensitive to assumptions. Small changes in growth rate or discount rate produce huge valuation swings. Garbage in = garbage out.
Graham NumberBeginnerBest for: Value investors / defensive investors
Step-by-step:
Formula: Graham Number = √(22.5 × EPS × Book Value Per Share)
The 22.5 comes from Benjamin Graham's rule: P/E ≤ 15 and P/B ≤ 1.5 (15 × 1.5 = 22.5)
If current price < Graham Number, stock may be undervalued
EXAMPLE
Company EPS = $4, Book Value Per Share = $20. Graham Number = √(22.5 × 4 × 20) = √1800 = $42.43. If the stock trades at $35, it's below the Graham Number.
⚠ Limits:Designed for defensive stocks. Technology and asset-light companies often have minimal book value — not suitable for them.
EV/EBITDAIntermediateBest for: Comparing companies across capital structures
Step-by-step:
Enterprise Value (EV) = Market Cap + Debt − Cash
EBITDA = Earnings before interest, taxes, depreciation, amortisation
EV/EBITDA = EV ÷ EBITDA
Lower ratio vs sector peers = potentially undervalued
EXAMPLE
Two companies: both have $500M EBITDA. Company A: EV = $4B → EV/EBITDA = 8×. Company B: EV = $7B → EV/EBITDA = 14×. Company A looks cheaper.
⚠ Limits:EBITDA ignores capital expenditures — not ideal for capital-heavy businesses. Always use alongside FCF.
The margin of safety — your most important concept
No valuation method is perfect. Estimates are based on assumptions that can be wrong. The margin of safety is the gap between intrinsic value and what you actually pay — it's your protection against estimation errors.
< 10%
Thin margin
Minimal protection. One bad quarter and you're underwater.
15–25%
Moderate margin
Acceptable for high-quality, predictable businesses.
30–50%
Strong margin
Benjamin Graham's preferred level — wide protection against being wrong.
"The margin of safety is the central concept of investment." — Benjamin Graham. Buying below intrinsic value doesn't just protect you from being wrong — it tilts the odds dramatically in your favor.
Quick Knowledge Check
3 questions · test what you've just learned
1
A profitable bank earns $4 EPS. Comparable banks trade at an average P/E of 11×. Using P/E-based valuation, what is the estimated intrinsic value?
2
Why is the DCF (Discounted Cash Flow) method considered the most sensitive to errors?
3
What is the primary purpose of demanding a 'margin of safety' when buying a stock?
✓ Key takeaways from Lesson 6
Intrinsic value is what a business is really worth — often different from its market price.
P/E-based valuation is the simplest method: EPS × fair P/E multiple.
DCF is the gold standard but highly sensitive to assumptions — always stress test yours.
The Graham Number works best for traditional, profitable, asset-heavy businesses.
Always demand a margin of safety: don't pay intrinsic value — buy at a discount to it.
Calculate intrinsic value instantly — free tool
BriMindInvest's Intrinsic Value calculator lets you run DCF and multiple-based valuations on any stock — just enter the ticker and it does the maths for you.