# Calculating Instrinsic Value



## ceasar73 (14 June 2007)

Hello friends

I find it difficult to calculate the intrinsic value of a share. I am aware that different investors use different techniques to calculate intrinsic value.

Do you know of a technique that works reasonably well?

Is there a book (preferably Australian) that is worth reading regarding this topic?

thanks

ceasar73.


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## stoxclimber (14 June 2007)

Industry standard is DCF & trading multiples
No need to buy a book since I'm sure you can find everything you need on the net
In fact, here's the leading book in the field...totally free (and totally LEGALLY free as well! No mod action needed here):
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valn2ed/book.htm


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## ceasar73 (14 June 2007)

fantastic stoxclimber thanks!

Does this industry standard work for you?

cheers,

ceasar73.


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## dhukka (14 June 2007)

stoxclimber said:


> Industry standard is DCF & trading multiples
> No need to buy a book since I'm sure you can find everything you need on the net
> In fact, here's the leading book in the field...totally free (and totally LEGALLY free as well! No mod action needed here):
> http://pages.stern.nyu.edu/~adamodar/New_Home_Page/valn2ed/book.htm




DCF models are fatally flawed. Here's an article that explains why:

http://www.stockval.com.au/documents/Questions_of_Intrinsic_Value_2_Stage_Models.pdf


Here's a basic article on intrinsic value:

http://www.stockval.com.au/documents/Company_Valuation_Stock_VAL.pdf

If you want a good book that goes through the basics of calculating intrinsic value try reading MARKET WISE by Brian McNiven.


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## stoxclimber (14 June 2007)

There's nothing "fatally flawed" about a DCF model. It's the industry standard because it is correct. I won't dig through a 5 page pdf report and refute every point made about DCF, but if you choose to post your major objections I will respond to them.

However, before you do, I believe it will alleviate much of your criticism if you consider whether you are critising the method per se, or the choice of input of the method. Naturally, one can value a company at nearly anything depending on the inputs, but if one uses CORRECT inputs one gets the CORRECT valuation - and that is unquestioned. And I don't see that article as disputing that point.

Also, I advise the reader that the *commercial company* that Dhukka is linking to is trying to sell a product named STOCKVAL for some  $858.00 + $67 per month. I would point out the following:

Anti-DCF [although I argue that they are not anti DCF, just antiDCF input]:
Clime aka StockVal [commercial company which is trying to sell a valuation software, thus naturally would be inclined to be negatively disposed to DCF]

Pro-DCF [without exaggeration:]
Countless academics around the world
Every or nearly every investment bank in the world
Every or nearly event private equity firm in the world
etc., none of which have an incentive to promote the use of DCF and in fact, would use a better method if one existed.


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## stoxclimber (14 June 2007)

ceasar73 said:


> fantastic stoxclimber thanks!
> 
> Does this industry standard work for you?
> 
> ...




As with everything ceasar, the skill is in the application! DCF in particular is particularly sensitive to small changes in input assumptions...as they say, more art than science, more bull**** than art!  Additionally, firms in a startup stage are harder to value using DCF than others..

I have had some success, although I can't say I attribute it to the use of DCF - generally as I am investing in smaller companies I tend to do sum of the parts (which is basically, if e.g. a company has 4 divisions you value each division seperately, using DCF or in my case generally comparables). However, I would say that, if you are investing in a company with a reasonably mature line of business, you should be able to whip up a rough DCF using relatively conservative estimates to support your valuation if its a decent buy.

A full blown DCF model requires a lot of macro and micro research that really is not practical for investment on a small scale, like I (and probably you) are doing.


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## dhukka (15 June 2007)

stoxclimber said:


> There's nothing "fatally flawed" about a DCF model. *It's the industry standard because it is correct. *




It's always amusing to watch personalities come apart when something they cling to as an unshakeable truth is questioned. That part in bold is hilarious. If you've ever worked in the industry (and I have as analyst in a mid-sized broking firm and used DCF's extensively) you'll know that many of their "standards" are far from correct and some downright criminal. 



> However, before you do, I believe it will alleviate much of your criticism if you consider whether you are critising the method per se, or the choice of input of the method. Naturally, one can value a company at nearly anything depending on the inputs, but if one uses CORRECT inputs one gets the CORRECT valuation - and that is unquestioned. And I don't see that article as disputing that point.




Sorry you didn't alleviate any of my criticism. There is no one "correct" valuation but a close approximation is the best one can hope for. You're obviously having trouble understanding the article if you think it's a question of inputs. 



> Also, I advise the reader that the *commercial company* that Dhukka is linking to is trying to sell a product named STOCKVAL for some  $858.00 + $67 per month. I would point out the following:
> 
> Anti-DCF [although I argue that they are not anti DCF, just antiDCF input]:
> Clime aka StockVal [commercial company which is trying to sell a valuation software, thus naturally would be inclined to be negatively disposed to DCF]
> ...




Clime (ASX: CAM) is an ASX listed investment company that returned 44% for it's clients last year. You don't need to pay what they are asking for the software if you just pick up the book I mentioned before which has all you need to know about company valuation including the proprietary formula developed by Clime for the Stockval system for around $24.95


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## ceasar73 (15 June 2007)

mmmmm....

The problem is both of you two make sense and seem to know what you are talking about. Need to investigate further.

thanks

ceasar73.


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## ceasar73 (15 June 2007)

Clime (ASX: CAM) is an ASX listed investment company that returned 44% for it's clients last year. You don't need to pay what they are asking for the software if you just pick up the book I mentioned before which has all you need to know about company valuation including the proprietary formula developed by Clime for the Stockval system for around $24.95[/QUOTE]

dhukka

Do you use Stockval? 

ceasar73


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## dhukka (15 June 2007)

ceasar73 said:


> Clime (ASX: CAM) is an ASX listed investment company that returned 44% for it's clients last year. You don't need to pay what they are asking for the software if you just pick up the book I mentioned before which has all you need to know about company valuation including the proprietary formula developed by Clime for the Stockval system for around $24.95
> 
> dhukka
> 
> ...




Yes I have both the book by the creator of stockval Brian McNiven and the keys to the Stockval system.


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## stoxclimber (15 June 2007)

dhukka said:


> If you've ever worked in the industry (and I have as analyst in a mid-sized broking firm and used DCF's extensively) you'll know that many of their "standards" are far from correct and some downright criminal.




I don't mean to be insulting, but a brokerage firm is hardly what I mean when I say industry. For the record, I've worked in investment banking IBD. 



> Sorry you didn't alleviate any of my criticism. There is no one "correct" valuation but a close approximation is the best one can hope for. You're obviously having trouble understanding the article if you think it's a question of inputs.




I notice you didn't post any specific DCF criticisms for me to respond to, rather than broadly asserting that I "didn't understand it". But it is false that there's no correct valuation. There is. But you can never be sure if you have reached it. 



> Clime (ASX: CAM) is an ASX listed investment company that returned 44% for it's clients last year.




Wow, I returned more than 44% last year. Does that mean I am right? No. The longest term Clime return available is 3 years where one fund returned 22.5% (compared to S&PASX200 of 20.31%, although they don't even seem to be using the accumulation index ) and the other fund returned 17.9%. 



> You don't need to pay what they are asking for the software if you just pick up the book I mentioned before which has all you need to know about company valuation including the proprietary formula developed by Clime for the Stockval system for around $24.95




Nevertheless, they are still SELLING this method. Of course, if one is selling a valuation method, one has a large  CONFLICT OF INTEREST when commenting on the standard.

You still haven't answered the point that, if DCF is "fatally flawed" as you say, why do so many people, who have absolutely no conflict of interest regarding use of DCF, such as every investment banking firm, every private equity firm, every academic etc., USE DCF?
If it really was fatally flawed, WHY ARE THEY USING IT?


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## ceasar73 (15 June 2007)

How well has it worked for you dhukka? 
Do you use any other tools? Recommend other books? Im trying to get a feel for how you pick your stocks.

thank you

ceasar73.


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## ceasar73 (15 June 2007)

"WHY ARE THEY USING IT?"

you make a good point here.

ceasar73.


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## dhukka (16 June 2007)

stoxclimber said:


> I don't mean to be insulting, but a brokerage firm is hardly what I mean when I say industry. For the record, I've worked in investment banking IBD.




Why do you assume when I say industry that I mean just broking?  I worked for a broking house but obviously had daily contact with Investment management firms and liased with corporate banking teams. Not all of them use DCF models to value companies.   




> I notice you didn't post any specific DCF criticisms for me to respond to, rather than broadly asserting that I "didn't understand it".





Really? How about the 6 page document that clearly outlines a number of flaws in the DCF methodology that I posted a link to to which you replied: 



> I won't dig through a 5 page pdf report and refute every point made about DCF




I fail to see after offering up this document as evidence of the dubious value of DCF's why the burden of proof rests with me when your entire argument rests on: 



> You still haven't answered the point that, if DCF is "fatally flawed" as you say, why do so many people, who have absolutely no conflict of interest regarding use of DCF, such as every investment banking firm, every private equity firm, every academic etc., USE DCF?
> If it really was fatally flawed, WHY ARE THEY USING IT?




Everyone used to think the world was flat, where they right? 

You're biggest impediment to understanding is your stubborness in thinking that you are in possession of the truth. I used to be one the DCF's biggest cheerleaders until I found a much more theoretically sound and practically applicable method. Clime's method is not perfect as no method is. I came to my conclusion after weighing the pros and cons of each approach and challenging some long held beliefs, something you seem to be unwilling to do. 



> Nevertheless, they are still SELLING this method. Of course, if one is selling a valuation method, one has a large  CONFLICT OF INTEREST when commenting on the standard.
> 
> You still haven't answered the point that, if DCF is "fatally flawed" as you say, why do so many people, who have absolutely no conflict of interest regarding use of DCF, such as every investment banking firm, every private equity firm, every academic etc., USE DCF?
> If it really was fatally flawed, WHY ARE THEY USING IT?



The above paragraph further demonstrates your level of confusion. A conflict of interest occurs when someone in a position of trust, such as a lawyer, a politician, an analyst, a physician etc. has competing professional or personal interests. Clime doesn't have competing interests, they are selling a product and in support of selling that product they have accumulated the best evidence in support of it and thus they have no conflict. To be clear Clime's main business is not the sale of this product.  They are primarily a listed investment company. 

btw typing responses in capital letters doesn't give your arguments any more validity - it's akin to shouting.


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## dhukka (16 June 2007)

ceasar73 said:


> How well has it worked for you dhukka?
> Do you use any other tools? Recommend other books? Im trying to get a feel for how you pick your stocks.
> 
> thank you
> ...




Ceasar, I have been back investing in the market for 7 months after a 5 year hiatus. I have not bought any stocks based on the Clime valuation methodology so I can't comment on it's effectiveness. Furthermore I would never buy a stock purely because I valued a company at less than it's current price. There are a range of other factors that need to be considered.


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## dhukka (16 June 2007)

Ceasar,
The book I recommended outlines other factors that are important in stock selection. The book's author is a big fan of Warren Buffet so if you are interested in this method you would be well advised to read Berkshire Hathaway's shareholders letters. Also another book of interest may be The Essays of Warren Buffett : Lessons for Corporate America. As for the current obsession with DCF's by industry analysts. It is a more a reflection of current fashion than any unassailable truth about the ability of the method to measure intrinsic value. 

If it were such an accurate method then why do industry analysts consistently manage to get as many calls wrong as they do right? Defenders of the method like Stoxclimber might argue that this has more to do with the application of the methodology than the methodology itself - the old garbage in garbage out rule. And while there is some validity to that argument it oversimplifies and draws attention away from the method's underlying problems.


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## stoxclimber (16 June 2007)

Dhukka,

I note your resort to the good old ad homs and that you can still not point a single point out of the 5 page document which you wish me to respond to. Therefore, this will be my last post and I'll let you go back to selling your commercial method.

However, I will respond to one last post for all readers out there who may be mislead:



> If it were such an accurate method then why do industry analysts consistently manage to get as many calls wrong as they do right?




If Clime's system was so good, why can't they massively outperform the market?  Why are people selling this amazing system, the key to untold riches, in a book for $25? 

People can't sell DCF since the foundations of DCF are published in many academic journals and are known the world round. I doubt whether the worlds "Clime Capital" have ever graced the pages of an academic journal.


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## dhukka (16 June 2007)

stoxclimber said:


> Dhukka,
> 
> I note your resort to the good old ad homs and that you can still not point a single point out of the 5 page document which you wish me to respond to.




Probably because I don't wish to point out any particular point for you to respond to. You are the one who wishes it. To isolate one point would not do justice to the article or the issue. The usual course of a debate or argument is two parties present their evidence and debate it. I have presented mine, you don't have any except for the flimsy platitude that DCF's are the industry standard and furthermore you are unable to refute the arguments set forth in the document. 



> Therefore, this will be my last post and I'll let you go back to selling your commercial method.



translation - because you won't play by my rules I'm going to take my bat and ball and go home



> However, I will respond to one last post for all readers out there who may be mislead:
> 
> If Clime's system was so good, why can't they massively outperform the market?




Why can't the proponents of DCF's massively outperform the market? Probably because as outlined in an earlier post there is a lot more to stock selection than valuation. Remember that's all the stockval product is - a valuation tool. There are a variety of other factors to take into account before buying stocks. Clime actually tell users of their system not to buy stocks just because they are undervalued.   



> Why are people selling this amazing system, the key to untold riches, in a book for $25?




Clime does not claim their system is the key to untold riches, that is your claim. 



> People can't sell DCF since the foundations of DCF are published in many academic journals and are known the world round. I doubt whether the worlds "Clime Capital" have ever graced the pages of an academic journal.




Well at least you continue to amuse. I currently work in academia and with the  enormous volume of worthless crap published in academic journals the fact that Clime's does not appear in any is probably a positive.

*Disclaimer: I do not work for Clime capital and do not earn a commission on any sales of the stockval system.*


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## ceasar73 (18 June 2007)

dhukka said:
			
		

> *Disclaimer: I do not work for Clime capital and do not earn a commission on any sales of the stockval system.*




Dhukka - from your honest answers regarding clime/stockval the above was obvious to me.

Thank you kindly for your help. I intend to read MARKET WISE. I have a million questions for you but don't wont to waste your time at this stage.

cheers,

ceasar73.


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## Inv (9 July 2007)

I've been doing a little research on value investing lately and have actually read a few of the Clime documents. I don't think they're perfect, but I get the general idea. To clarify, I don't think Clime are disputing DCF; in fact, they use a DCF model. As per the title of the document in question, it's the two-stage model that they are disputing.

Personally, I think it's impossible to dispute the DCF model; it is what it is. But the two-stage model introduces a number of complexities that can be questioned.

Also to clarify, the two-stage model seems to be a DCF value over a definitive period + a perpetuity value from the end of the DCF period onwards. Apparently if you use the model to value a bond (of course one without a maturity), you get an incorrect value. I haven't confirmed this though.

Anyway, I just thought this thread needed some clarity.  I'm still researching the claims of Clime, so I can't say either way whether they're correct.


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## Charlie (22 July 2007)

Just to add my 2 cents to this thread, and preface by saying I am a (very small) shareholder of CAM, but not a subscriber of Stockval (asset base too small to justify subscription).

I have read Brian McNiven's books: "wonderful company at a fair price" and "Market Wise". Of the 2, I prefer the first. The books are NOT merely espousing a valuation methodology, but spend a considerable number of pages on how to identify a wonderful company: whose management acts rationally (ie in SHAREHOLDERS interest rather than for directors interests:they're not necessarily the same); that has pricing power; has longevity (several years of profits); that represent accounts in clear way; and have growth prospects. Of course, having identified a company with such great characteristics, one needs to know how much to pay, which is where his valuation method comes in. And dividend policy makes a big difference to valuations in his model: the "fair price" for a company with high ROE is higher if that high ROE is maintained on low div payout than if it pays out all divs (obvious when you think about it: if a company can generate 20%+ ROE p.a. over several years without paying a div, it means they're growing that company at a much higher COMPOUND rate than if they paid all their earnings out as divs, something that should be obvious from Berkshire Hathaway).

The formulae for valuing a company are in "Market Wise", but it's not a trivial exercise to make an excel spreadsheet with those formulae. I understand that there are 3-400 ASX stocks valued by Stockval in the subscription, as well as  "blanks" to do your own analysis.

I would suggest read the books and see if what you read makes sense to you. 

There are many ways to achieve wealth in the markets, and I am still learning that I am most likely to be comfortable with methods that fit my emotional, psychological, and intellectual understanding.


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