As an investor, do not chase headlines.
A stock is “hot,” property prices in Lekki are “booming,” or Treasury Bills are “safe.”
Always remember underneath the noise, every asset has something more fundamental: its intrinsic value.
That is what separates:
- Market value (what people are paying today) from
- Real value (what it is truly worth).
What is the intrinsic value?
Intrinsic value is simply the real worth of an investment, based on the cash it will put in your pocket in the future, but expressed in today’s naira.
This means you must factor in:
- The return you expect,
- The opportunity cost of investing elsewhere,
- The probability of getting your money back, and
- The impact of inflation or price level changes.
Think of it this way:
An investment of N1 million in government securities (Treasury Bills or bonds) that promises N5 million in 10 years is not the same as an investment of N1 million in corporate bonds that promises the same N5 million in 10 years.
The role of the discount rate
So how do you actually estimate the real value of your investment today?
That’s where the discount rate comes in. The discount rate is simply a measure of risk and opportunity cost.
It answers the question:
“What return could I earn elsewhere with similar risk?”
The rule is simple: the riskier the asset, the higher the discount rate you must apply.
Let’s bring this home with an example.
- Ada and Kunle each have N5 million to invest in.
- Ada puts hers in a government bond that promises N10 million in 5 years.
- Kunle chooses a corporate bond that promises N15 million in 5 years.
At first glance, Kunle’s deal looks better; N15 million beats N10 million. But when we apply the discount rate:
- Ada’s government bond (discounted at 10%) is worth about N6.21 million today.
- Kunle’s corporate bond (discounted at 20%) is worth about N6.03 million today.
Surprisingly, Ada’s government bond has slightly higher intrinsic value than Kunle’s corporate bond.
Why? Because government securities are considered risk-free, no matter the situation, the government must pay it back. But a company can run into trouble and fail to pay.
- So, investment must compensate for the risk being taken
The key lesson? The same N5 million in the future is not always worth the same as today. The higher the risk, the higher the discount rate, and the lower the present value of those future cash flows.
To surpass the intrinsic value of Ada’s government bond, Kunle’s corporate bond would need to promise at least N15.45 million in 5 years, not just N15 million.
This shows the extra reward investors must demand to take on a higher risk. Without it, the seemingly bigger payout is actually worth less in today’s terms.
The investor’s takeaway
So, before you jump on the next “hot” stock, “booming” property, or “safe” investment, pause and ask:
“What is the intrinsic value of your investment, after accounting for risk, time, and opportunity cost?”
Because that’s the difference between chasing paper wealth and building real value.
To get our exclusive buy, sell or hold views on stocks and regulated investments, subscribe to www.FTM.Ng.
Beautiful piece, very edifying..