
Binarium
The Best Binary Options Broker 2020!
Good for Beginners!
Free Education + Free Demo Account!
Get Your SignUp Bonus Now!
Time Value of Money
Time is money. Any sum of money payable in the future is worth less than if it is paid today. This is because that sum of money, if paid today, can be put into an interest bearing bank account to earn interest.
Present value
The present value of that future sum can be determined using the following formula.
PV = FV/(1 + r) n
where PV = Present Value, FV = Future Value, r = interest rate and n = number of years
Example
At 5% interest rate, the present value of a $1000 payment in 3 years’ time is only $863.84.
Future value
Correspondingly, there exist a future value of any sum of money can be computed using the following formula.
FV = PV(1 + r) n
where PV = Present Value, FV = Future Value, r = interest rate and n = number of years
Example
At 5% interest rate, the future value of $1000 in 3 years’ time is $1157.63.

Binarium
The Best Binary Options Broker 2020!
Good for Beginners!
Free Education + Free Demo Account!
Get Your SignUp Bonus Now!
You May Also Like
Continue Reading.
Buying Straddles into Earnings
Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results. [Read on. ]
Writing Puts to Purchase Stocks
If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount. [Read on. ]
What are Binary Options and How to Trade Them?
Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time. [Read on. ]
Investing in Growth Stocks using LEAPSÂ® options
If you are investing the Peter Lynch style, trying to predict the next multibagger, then you would want to find out more about LEAPSÂ® and why I consider them to be a great option for investing in the next MicrosoftÂ®. [Read on. ]
Effect of Dividends on Option Pricing
Cash dividends issued by stocks have big impact on their option prices. This is because the underlying stock price is expected to drop by the dividend amount on the exdividend date. [Read on. ]
Bull Call Spread: An Alternative to the Covered Call
As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement. In place of holding the underlying stock in the covered call strategy, the alternative. [Read on. ]
Dividend Capture using Covered Calls
Some stocks pay generous dividends every quarter. You qualify for the dividend if you are holding on the shares before the exdividend date. [Read on. ]
Leverage using Calls, Not Margin Calls
To achieve higher returns in the stock market, besides doing more homework on the companies you wish to buy, it is often necessary to take on higher risk. A most common way to do that is to buy stocks on margin. [Read on. ]
Day Trading using Options
Day trading options can be a successful, profitable strategy but there are a couple of things you need to know before you use start using options for day trading. [Read on. ]
What is the Put Call Ratio and How to Use It
Learn about the put call ratio, the way it is derived and how it can be used as a contrarian indicator. [Read on. ]
Understanding PutCall Parity
Putcall parity is an important principle in options pricing first identified by Hans Stoll in his paper, The Relation Between Put and Call Prices, in 1969. It states that the premium of a call option implies a certain fair price for the corresponding put option having the same strike price and expiration date, and vice versa. [Read on. ]
Understanding the Greeks
In options trading, you may notice the use of certain greek alphabets like delta or gamma when describing risks associated with various positions. They are known as “the greeks”. [Read on. ]
Valuing Common Stock using Discounted Cash Flow Analysis
Since the value of stock options depends on the price of the underlying stock, it is useful to calculate the fair value of the stock by using a technique known as discounted cash flow. [Read on. ]
Value Investing 101: Intrinsic Value (Part 1)
What is Intrinsic Value?
If you’ve read any of the articles on this website – or if you’re familiar with value investing concepts – then you may know that an Intelligent Investor will only buy a stock when its market value (that is, its stock price) is less than its intrinsic value.
In other words, a smart investment is one where you are buying a stock for less than its intrinsic value.
But what exactly is intrinsic value and how do you calculate it?
In the Berkshire Hathaway Owner’s Manual, Warren Buffett writes this about intrinsic value:
Viewing a Business as a Bond
What does Buffett mean by this? Imagine a bond, for instance, which pays the bondholder interest every year and principal back at maturity. From Value Investing 101: The Time Value of Money, we know that a dollar today is worth more than a dollar tomorrow, and vice versa that a dollar tomorrow is worth less than a dollar today. Therefore, the interest and principal payments we receive in the future must be discounted to a lower value in order to determine their value today.
So, the present value of a bond = the discounted value of the bond’s future interest and principal payments. (If this doesn’t make sense, then please read my Time Value of Money article before reading on).
Now picture a company.
What is the purpose of a company? Answer: To generate dividends for the company’s shareholders.
This is a lot like a bond isn’t it? Except instead of being paid interest every quarter, a shareholder is paid dividends every quarter. This means you can discount the value of future dividends just the same way that you can calculate a bond’s future interest and principal payments.
Remember that the present value of a future payment = the future value of the payments, discounted at a certain rate?
In math form, this equation is the following (where i = the discount rate):
If the future payments will growth at a constant rate, then the equation can be simplified as:
The above equation is called the Dividend Discount Model (or the Gordon Growth Model) and its output is the intrinsic value of a stock.
Limitations of the Dividend Discount Model
“But,” you might argue, “not all stocks pay dividends, and even the ones that do pay dividends don’t have a consistent dividend growth rate.”
You’re right, of course. Unlike with a bond, a company doesn’t have any contractual obligations to pay a dividend to its shareholders.
Furthermore, dividends alone don’t capture all of a company’s earnings. Besides paying a dividend, a business can also use the cash it generates to acquire new equipment or machines, to improve its factories or buildings, for research & development, to acquire another company, or to make other investments.
Any of these can be a better allocation of capital than if the company had paid a dividend. So while the dividend growth model (DDM) provides a good framework to understand intrinsic value, it doesn’t actually generate a realistic result.
Next Up: DCF and Owner Earnings
In Part 2, we’ll take the DDM one step further and will use a Discounted Cash Flow analysis to calculate a more accurate intrinsic value of a stock.
Did you like this article? Do you know someone else who is interested in value investing? Please share this article!
Stock Investing 101 – Time Value of Money
No retirement account?
See the best options
NerdWallet Compare, Inc. NMLS ID# 1617539
California: California Finance Lender loans arranged pursuant to Department of Business Oversight Finance Lenders License #60DBO74812.
Disclaimer: NerdWallet strives to keep its information accurate and up to date. This information may be different than what you see when you visit a financial institution, service provider or specific product’s site. All financial products, shopping products and services are presented without warranty. When evaluating offers, please review the financial institution’s Terms and Conditions. Prequalified offers are not binding. If you find discrepancies with your credit score or information from your credit report, please contact TransUnion® directly.

Binarium
The Best Binary Options Broker 2020!
Good for Beginners!
Free Education + Free Demo Account!
Get Your SignUp Bonus Now!