"What is investing if it is not trying to find value?" Business value or intrinsic value is not the same as market capitalization of a company. Market capitalization of a publicly traded company is the value assigned by the stock market at any given time which is influenced by various things from market participants' view of current business condition of the company, industry, and general macroeconomic condition of a country among others; therefore, market cap is independent of business value (intrinsic value). In general, intelligent investors (for common stock investors) should adjust the market capitalization of a publicly traded company to include the dilution effects of employees and executives' stock options (treat them as expenses) as well as all senior securities (e.g.: preferred stocks, convertible securities, warrants, etc.) that appear on the company's balance sheet statement.

Calculating the intrinsic value of a business are both artistic and scientific in nature; and hence, two very intelligent investors or businesspersons analyzing the same company may come up with different intrinsic value figures and opinions. The discrepancies may be wide. Valuing a business requires at least a general understanding of basic business knowledge especially accounting and finance, and high dose of common sense. The first step you should know as an investor is definitely to know how to decode company's financial statements which consist of: income statement, balance sheet statement, cash flow statement, shareholder equity statement, and important notes and disclosures to financial statements. In addition, it is equally important for investors to read top management annual letters (usually part of the company's annual report) in order to learn about the company's business model, track-record, and management tone, etc. To be a great investor, one does not need to be a business, finance, or accounting graduate. Common-sense is the keyword here. Anyone with IQ above 80 can be a great investor as long as he/she wants to learn few basic things as recommended by Warren Buffett, the greatest investor of all time:

1. Learn how to value a business.
2. Learn how to think about stock market (hint: be patient; in the long-run, the market is a weighing machine, not a voting machine)

"In investing, you should learn from the ways women shop." - Peter Lynch, One Up on Wall Street.

Understanding the two key things above can simplify your life as an investor and increase your chance to be a successful investor. Now, how to value a business? For the sake of simplicity, intrinsic value of a business basically consists of two valuation components:

1. Net-Net Assets Value (NNAV) as coined by Benjamin Graham, the father of the security analysis; and

2. Owner's Earning (OE) or Free Cash Flow (FCF) Value as hinted by Warren Buffett in several occasions in his annual reports' letters to shareholders.

In short, the formula to calculate Intrinsic Value is:

Intrinsic Value = Net-Net Asset Value + Owner's Earning Value

For conservatism, Net-Net Asset Value (NNAV) here is the net liguidation asset value that common stockholder can extract out of the company if the business goes under or bankrupt as a going concern. Simply you can calculate NNAV using this formula below:

NNAV = Adjusted Current Assets - (Total Liabilities + Total Value of Senior Securities)

Adjusted Current Assets are current assets that can easily be converted into cash within a year. Caution needed here; for example: in the retail apparel business, the inventory value of finished goods may be overstated since it is hard to know the current market value of the finished goods' in the ever-changing trend & styles of apparels. Therefore, in this kind of situation, the value of the finished goods inventory should be adjusted to zero or maybe 10-15% of the stated value on the balance sheet. On the other hand, if you are dealing with company that has hidden valuable assets not shown in the balance sheet such as some land-rich railroad companies, the value of the assets may be adjusted upward accordingly provided you know the current approximate value of these hidden assets.

Total liabilities are the sum of Current Liabilities and Long-term Liabilities such as long-term debts and obligations.

Total Value of Senior Securities is the value of preferred stocks, warrants, and hybrid securities such as some flavors of convertible preferred stocks, warrants, and other exotic senior securities that appear on the balance sheet's liability side because after all, these securities will be true liabilities just like long-term debts for common stockholders/shareowners.

Owner's Earning or Free Cash Flow is the total amount of economic net cash in-flow you can extract from the business's entire lifetime discounted to present time using long-term average required annual rate of return to beat inflation rate, long-term government bond rate, and other necessary risk premium rates . What is important here is the accuracy of the growth projection of the free cash flow generation of the business which requires deep understanding of the characteristic of the business and its industry as well as the condition of general economy going forward. Moreover, investor should analyze the profitability of the business operation (e.g.: analyzing the business' Gross Profit Margin, Pre-tax margin, Net Profit Margin, Net Operating Margin, Asset Turnover, Return on Invested Capital, Return on Assets, and Return on Equity among others) as well as to be able to conclude on the company's long-term sustainability.

Combination of macro and microeconomics analyses are also required to gauge and to analyze the competitive advantages of any businesses. For example: Coca Cola has very strong competitive advantages understanding intelligently that Coke is now still the no.1 choice among soft-drinkers and one of the most recognizable brands on earth. In addition, Coke also has massive sales & distribution channels spanning virtually in every corner of the world. Analyzing that there are still many potential long term major markets such as China and Africa, one can conclude that Coke still has quite long competitive advantage period, probably more than 30 years. On the other hand, like many of investors or traders (who mistakenly consider themselves investors) have known and learned bitterly, there were many dot-com businesses that generate nothing in 1998-2000, had virtually no competitive advantage, and yet were valued at extraordinary level by the psychologically driven "go-go" bull market in the late 1990's. The subsequent performance results of these companies since 2000 have been disastrous. The same applies with many speculative oil & gas exploration companies in 2007-2008; many are now facing tremendous difficulties due to significantly lower oil & gas prices.

In short, Owner's Earning Value formula is:

Owner's Earning Value of Free Cash Flow Value = The sum of all economic cash that the business can generates throughout its lifetime discounted to the present time using appropriate long term risk-free discount rate

One should notice however, that the value of the company's management team has not been included yet in the Intrinsic Value calculation above. Why? Because it is very hard to value the management team. What investors should expect is to be able to find truly great companies that are managed by honest, capable, and shareholder-oriented management teams, key-decision makers, and insiders. The bigger the % ownerships of common stocks that the top level managements have, the higher is the chance these top guns would act and do business on behalf of maximizing value and return for their shareholders.

The above explanation on business valuation is only a simplified version of a much longer explanation and therefore shall not be used as the only basis to value a business in great detail.

"The market is a voting machine in the short term and a weighing machine in the long term." - Benjamin Graham.

Notice: Author is co-founder of Sovestor.com and managing partner of a value-oriented private investment company.