Usually, in fundamental analysis, both the quantitative and qualitative aspects of a company’s performance are taken into account. While the former involves the use and analysis of the financial ratios, the latter is aimed at understanding the strength of the company’s management.
Intrinsic value is usually followed as the baseline after having considered various factors such as the ROE, EPS, D/E, P/E and the growth rate of the company. Using all these aspects, we can make an approximate, near accurate guess of the future earning and prospects for the company and consequently, arrive at an intrinsic value of its shares. Financial ratios and their analysis are used to derive the real value of a share and using this value, we can get a fair indication of whether the shares of the company are overvalued or undervalued in the market.
The power of intrinsic values cannot be ignored and a reminder of this was the market crash of the late 90s. During the 90s, people were willing to pay high prices for technology and internet shares and the analysts were shying away from valuing the companies based on their intrinsic values.
The analysts were not able to justify the high price being paid by the people and would just conclude that if the company had exceeded the quarterly earning estimates, then the high price was a worthy bargain. The analysts were proven wrong with the market crash.
Intrinsic values, like live stock prices, are not static and change over a period of time (everyday, on an average), but they do not change as frequently as the actual stock prices might. A large difference between the intrinsic value and the actual share price cannot co-exist. If this difference starts to grow, something needs to be looked at.
Either, you would need to work out ways to increase the intrinsic value, or the stock prices would plummet some time in the future- the Intrinsic values to be decided by someone are usually a function of that person’s risk bearing capacity.