# Intrinsic value help



## viciam (29 March 2012)

Hi all,

I am trying to get an understanding of intrinsic value and I was hoping someone can help me. 

Imagin I am about to sit down with an annual report of a company infront of me, all the fundamentals look good and now I am about to estimate the intrinsic value....

Which ratios, formulas, numbers do I need in front of me that will allow me to estimate an IV. Please tell me everything I need to gather and have infront of me which I need to calculate IV. 

Thank you in advance


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## craft (29 March 2012)

viciam said:


> Hi all,
> 
> I am trying to get an understanding of intrinsic value and I was hoping someone can help me.
> 
> ...




The key is to really recognise that because you can’t know the future the best you can ever come up with is a estimate.

If you are just starting out then you would be far better off putting your time into learning how to manage risk in the face of uncertainty. That’s far more important.

You can come back to refining a valuation estimate once you have the important things sorted. At that time this is as good a link as any to get your head around the topic. It will take you time to understand it all.

http://pages.stern.nyu.edu/~adamodar/


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## McLovin (29 March 2012)

craft said:


> The key is to really recognise that because you can’t know the future the best you can ever come up with is a estimate.




Exactly.

I also suggest to the OP playing around with the numbers. See what happens when you change revenue projections or if WC changes. Have a bit of a range, if nothing more it will get you to think about the business and what is driving profitability and costs.


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## viciam (30 March 2012)

Appreciate the feedback guys, I will be reading that link you posted tonight Craft

But my original question still remains, what numbers do I need in front of me to actually calculate the IV?


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## McLovin (30 March 2012)

Depends on the model.


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## craft (30 March 2012)

viciam said:


> Appreciate the feedback guys, I will be reading that link you posted tonight Craft
> 
> But my original question still remains, what numbers do I need in front of me to actually calculate the IV?



 You need to Know ALL FUTURE profits - see a problem.

That link has enough to keep you going for years before you get your head around it. It will answer your questions if you put the time in.

Ultimately the answer is that IV is subjective so it doesn't matter how you estimate it. It’s a guess that with lots of time and skill you may get better at but ultimately the most important thing is that you can mange being wrong. 

If you want to make money investing, Learn how to manage being wrong. You will do better with a random selection and good risk management then you will with an awesome IV estimation and no risk management.

All IV formulas are short cuts for estimating and all have failings.

If you knew the future with 100% certainty then DCF would give you the most accurate IV.


Doubt that you are going to get spoon fed by anybody unless they know as little as you or have got something to sell by convincing you of their magic formula.


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## odds-on (30 March 2012)

craft said:


> You need to Know ALL FUTURE profits - see a problem.
> 
> That link has enough to keep you going for years before you get your head around it. It will answer your questions if you put the time in.
> 
> ...




There is a magic formula 

http://en.wikipedia.org/wiki/Magic_Formula_investing

Focus on the expected value of an investment.


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## Ves (31 March 2012)

odds-on said:


> There is a magic formula
> 
> http://en.wikipedia.org/wiki/Magic_Formula_investing
> 
> Focus on the expected value of an investment.



Hmm, it would appear that I am doing something very similar to this at the moment. The only difference is that I am trying to put more effort into understanding the business model & things such as competitive advantages. I believe that this is more important (at least to me) than any formula whilst I am learning.


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## odds-on (31 March 2012)

Ves said:


> Hmm, it would appear that I am doing something very similar to this at the moment. The only difference is that I am trying to put more effort into understanding the business model & things such as competitive advantages. I believe that this is more important (at least to me) than any formula whilst I am learning.




I believe Mohnish Pabrai has stated that using a magic formula screen is an excellent place to start when looking for companies to invest in. I personally like the cheap and safe criteria suggested by the author in the link below:
http://www.ndir.com/SI/articles/0112.shtml

IMO, the second one is more suited to the ASX. I spend a lot of my time thinking about a quantative value investing strategy for the asx, especially  after I read an article in afr smart investor about an investor who had got +20% returns for years by just crunching data and following a strict capital management plan. It comes down to competence and ability. Do you think you are better at guessing the future or sticking to some strict rules? It is a serious question an investor has to ask themselves.

How does this help the OP you ask? Sometimes an investor does not need to know the IV.

Cheers

Oddson


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## McLovin (31 March 2012)

From the website odds-on posted:



> The ratio of earnings-before-interest-and-taxes to interest-payments is called interest coverage and I like this ratio to be at least two or more




This seems incredibly low. I usually go for at least 4 and prefer over 5.


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## craft (31 March 2012)

odds-on said:


> I believe Mohnish Pabrai has stated that using a magic formula screen is an excellent place to start when looking for companies to invest in. I personally like the cheap and safe criteria suggested by the author in the link below:
> http://www.ndir.com/SI/articles/0112.shtml
> 
> IMO, the second one is more suited to the ASX. I spend a lot of my time thinking about a quantative value investing strategy for the asx, especially  after I read an article in afr smart investor about an investor who had got +20% returns for years by just crunching data and following a strict capital management plan. It comes down to competence and ability. Do you think you are better at guessing the future or sticking to some strict rules? It is a serious question an investor has to ask themselves.
> ...




Hi Oddson

I think I have recommended James Montier's value investing to you in the past - have you had a chance to read it yet. Suspect it would be right up your alley.


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## Ves (1 April 2012)

craft said:


> Hi Oddson
> 
> I think I have recommended James Montier's value investing to you in the past - have you had a chance to read it yet. Suspect it would be right up your alley.




Thanks - i'll check it out as well. Willing to read as widely as possible in the value investing field at this point.


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## craft (1 April 2012)

Ves said:


> Thanks - i'll check it out as well. Willing to read as widely as possible in the value investing field at this point.




Hi V

Montier’s Value investing book is aimed at the systematic, formula based, historically researched, mean reverting end of value investing – the reason I think Oddson might like it. 

Not much about quality companies and competitive advantage – but great reading as to why you shouldn’t get too carried away in paying for growth.

He is now employed at GMO and you can access his regular articles through there. IMO GMO is well worth having bookmarked.

http://www.gmo.com/Asia-Pacific/GMOInsights/

Cheers


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## Ves (1 April 2012)

craft said:


> Hi V
> 
> Montier’s Value investing book is aimed at the systematic, formula based, historically researched, mean reverting end of value investing – the reason I think Oddson might like it.
> 
> ...




Thanks again - I will check the site out. I will also read the book if I can find it; I do find that sort of thing interesting, even if I do not find or have any need to implement it.

Do you have any reading suggestions on competitive advantage (have read Greenwald) or business analysis (things such as earnings risk and understanding return on equity over time)?

edit: also sent you a PM last week; not sure if your inbox is full or you perhaps overlooked it?


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## odds-on (1 April 2012)

craft said:


> Hi Oddson
> 
> I think I have recommended James Montier's value investing to you in the past - have you had a chance to read it yet. Suspect it would be right up your alley.




Hi craft,

Not yet, i have been busy unfortunately. From the reviews on amazon it seems like it could be similar to Contratrian Investment Strategies: The Next Generation by David Dreman - is it? The book by David Dreman was a good read and is at the library . The library does not have anything by James Montier.

I will see how my picks have performed when i do my annual review in a few months time, if the CAGR does not meet the bar, then i will convert to a systematic value investing approach. I believe in value investing, i just do not believe that the IV/extraordinary approach is best for me (the returns do not justify the hours).

Cheers

Oddson


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## tinhat (1 April 2012)

Don't mean to hijack this thread with a left field comment but... I haven't read any of the external links provided so far (will do so), but ... my experience in chasing under-valued stocks using IV analysis (fundamental analysis) so far (since 2010 when I took over the family SMSF) in this secular bear market has been... the biggest problem has been timing. I've bought stocks that were considerably undervalued (and have since proven this to be true rising 15, 20, 30% over the past couple of years, yet I have been stopped out of them - often 15% below what I paid, because I haven't got the timing right and followed the momentum. Unless you don't implement stop losses and are prepared to watch your capital fluctuate very substantially based on the conviction of your stock picks, the last couple of years have been a nightmare for simply choosing undervalued strong balance sheet companies (with great forward earnings growth and return on equity forecasts) without also getting the momentum and market sentiment right.

I can give you a pile of stocks I bought into trying to rebalance the SMSF portfolio toward a more balanced and fundamentally sound footing that I got stopped out of (at a loss) only to see the price recover and my on paper decisions to be vindicated in recent times:

MTU
IIN
FLT
SEK
WEB

Additionally, I am sitting on paper losses on several other stocks in my portfolio:
MML
TGA
RCG

because I bought based on discount to perceived IV without taking note of the market sentiment and price momentum (TA).

Hopefully, in the long run these stock picks will still be winners. But as with those stocks I've been stopped out of in the past, watching your capital base fluctuate by 20% is not for the faint hearted, and not a prudent investment strategy for a SMSF (with members in pension mode). So, IV, I agree is important, but not the only step. As with show biz and the art of making love, timing is everything.


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## odds-on (2 April 2012)

tinhat said:


> Don't mean to hijack this thread with a left field comment but... I haven't read any of the external links provided so far (will do so), but ... my experience in chasing under-valued stocks using IV analysis (fundamental analysis) so far (since 2010 when I took over the family SMSF) in this secular bear market has been... the biggest problem has been timing. I've bought stocks that were considerably undervalued (and have since proven this to be true rising 15, 20, 30% over the past couple of years, yet I have been stopped out of them - often 15% below what I paid, because I haven't got the timing right and followed the momentum. Unless you don't implement stop losses and are prepared to watch your capital fluctuate very substantially based on the conviction of your stock picks, the last couple of years have been a nightmare for simply choosing undervalued strong balance sheet companies (with great forward earnings growth and return on equity forecasts) without also getting the momentum and market sentiment right.
> 
> I can give you a pile of stocks I bought into trying to rebalance the SMSF portfolio toward a more balanced and fundamentally sound footing that I got stopped out of (at a loss) only to see the price recover and my on paper decisions to be vindicated in recent times:
> 
> ...




Tinhat,

Do you have some simple timing indicators you would recommend? I am currently creating my own value investing system and would be interested in some simple TA indicators.

Cheers

Oddson


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## craft (2 April 2012)

odds-on said:


> Tinhat,
> 
> Do you have some simple timing indicators you would recommend? I am currently creating my own value investing system and would be interested in some simple TA indicators.
> 
> ...




Do not underestimate the difficulty of having two masters. At the most critical time they will not agree.

‘To my wife and sweetheart – may they never meet’

In my view both TA and FA are wonderful tools – but only in isolation. I know many disagree with me though and try to use both but eventually both tools come together with conflicting demands and you will have to make a decision under extreme fire.  Jump the wrong way and you can quickly lose any edge that either tool afforded.

TA is much easier to control risk with – but it will kill any FA edge.

In saying the above - I do consider TA but it is very much subordinated in my decision making process and mainly confined to entry and alerting me to really pay attention.


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## odds-on (2 April 2012)

Craft,

Points taken. Did you see my earlier comment regarding James Montier book and David Dreman? I do not want to buy the book if it is the same as David Dreman works. I have an understanding  the odds with respect to low P/E, low P/B stock etc beating the market and I have done my own research on business failure. I spend sometime surfing the net about James Montier and he has some good screening ideas - bascially a rehash of Benjamin Graham concepts. Is the book worth it?

Cheers

Oddson.


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## craft (2 April 2012)

odds-on said:


> Craft,
> 
> Points taken. Did you see my earlier comment regarding James Montier book and David Dreman? I do not want to buy the book if it is the same as David Dreman works. I have an understanding  the odds with respect to low P/E, low P/B stock etc beating the market and I have done my own research on business failure. I spend sometime surfing the net about James Montier and he has some good screening ideas - bascially a rehash of Benjamin Graham concepts. Is the book worth it?
> 
> ...




I haven’t read anything by David Dreman but from what I know of Dreman he does invest in a similar style to the content of Montiers book.

Personally I think it was a good book (actually very good).  I borrowed it, I don’t own it.  I make a point of reading James Montier’s articles at GMO (free)  – He’s a very thought provoking writer. He seems to be very much up the same track as you are looking.  The book was made up largely of articles written when he was at Society Generale  – you can probably still find most of these on the net.


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## tinhat (2 April 2012)

odds-on said:


> Tinhat,
> 
> Do you have some simple timing indicators you would recommend? I am currently creating my own value investing system and would be interested in some simple TA indicators.
> 
> ...




Oddson, I've come to the conclusion that one needs to combine both fundamental analysis of intrinsic value with momentum trading technical analysis in this secular bear, sideways moving market.

The most simple way to state trend/momentum trading is to buy a stock when both its price and the general market is in an up trend.

I'm only a novice, and have just started looking into trend/momentum trading. Some things I have come across:

MACD - MACD above signal line, on an upward trend, especially once it has crossed over zero. I use standard MACD settings on a weekly chart.

RSI (relative strength index).

Stochastic Oscillator - good for timing entries and exits, wait for pull-back for a buy. Also note that on a weekly chart, the stochastic oscillator can remain in the "overbought" range above 70 for months while the stock price keeps running up while buyers keep jumping on the bull run.

It can also be useful to view a daily price chart with the above indicators, but with their parameters adjusted so they use weekly rather than daily data - this displays nice smooth trends. For example, on the daily price chart, plot the MACD with the values (long 130, short 60, signal 45).

Moving Averages. I use simple moving averages (because I am a simple man). I look for golden cross (10 week above 40 week) as a bullish signal. You can use multiple moving averages (Guppy MMA or variations such as Alan Hull's Actvest MMA).

There are quite a few well respected momentum trading systems; such as Alan Hull's ActVest and Colin Nicholson. Stan Weinstein's "Secrets For Profiting in Bull and Bear Markets" also outlines a basic momentum trading strategy.

Basically, the above are all just statistical tools to help identify the price trend. If you read tech/a's thread on technical analysis the market is always in one of four phases, down-trend, accumulation, up-trend, distribution. Get in on the up trend and use a trailing stop loss system to get out at the beginning of the down trend. Use discretion to take profits, reduce exposure as you hit your targets or to close a position to take advantage of a better opportunity elsewhere.



craft said:


> Do not underestimate the difficulty of having two masters. At the most critical time they will not agree.
> 
> ‘To my wife and sweetheart – may they never meet’
> 
> ...




I can't disagree with you more. One may have married their wife based on a sound fundamental analysis (but lets face it it was probably more because of emotion) and it might work out to be a good investment in the long run, but knowing where she is in the cycle can help ease the pain of making moves at the wrong time!

I read something in a link posted on this forum the other day about the investor that just wants the middle of the fish - others can have the tail and the head. That is very much my thinking these days. I won't pick the bottom and I won't pick the top but the middle will do me just fine.

Grab your short list of fundamentally sound companies with IVs you believe to be well above the market price. A lot of the stock prices will be in down trend or in an accumulation phase without any sign of recovery or worst still, may look as though they might just be about to turn around (because you know that if the market was rational the price would be going up right?). Identify any on that list that are are showing bullish signs. If the MACD has already run up well over zero, if the RSI and the Stochastic oscillator are already into overbought you may have missed out on most of the current bull run. If the short term MAs are well above the long term MAs (example 10week MA above 30 week MA) and you believe based on fundamentals the stock price has not yet reached its true value then you can still hop on by buying the dip and put your stop-losses in place. I though, would rather wait for another opportunity to arise where I could hop on earlier.

I do have some stocks that are income stocks that I don't look at the price of. I'm very happy with the price I paid and the yield they are achieving. For all my other growth stocks, given that more likely than not the market is going to remain sideways for some time as just as likely to experience a major break out to the down side as the upside into the foreseeable future, I'll be using fundamental analysis to pick short lists of undervalued stocks but waiting for the right technical signals to place my entry and hopefully I will be executing exits to realise profits better than I have in the past two years!

Actually, if investing in the stock market is at all analogous to relationships with the opposite sex, no wonder I'm in such trouble!


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## craft (2 April 2012)

tinhat said:


> I can't disagree with you more




That's fine - I say you would be in the majority there.


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## tinhat (2 April 2012)

Oh yeah, one more thing I've been noticing lately is looking for divergent signals. Example TGA. Looking a the price action the price has been in a down trend since January 2011. Personally, I think it is worth more than the ~ $2.20 it hit in January 2011, but the price has been in down trend since and the MACD on the weekly chart (along with the RSI and Stochastic) back this up. Note however that while the price has continued to slip (and all the moving averages 10 week and upwards) are still showing a down trend, since around November 2011 the MACD on the weekly chart has diverged and is pointing up. So, while there is no entry signal yet for TGA it is one to watch more closely as it looks like it will find support around these level and is entering accumulation and should turn around at some stage.


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## Ves (2 April 2012)

tinhat said:


> Oh yeah, one more thing I've been noticing lately is looking for divergent signals. Example TGA. Looking a the price action the price has been in a down trend since January 2011. Personally, I think it is worth more than the ~ $2.20 it hit in January 2011, but the price has been in down trend since and the MACD on the weekly chart (along with the RSI and Stochastic) back this up. Note however that while the price has continued to slip (and all the moving averages 10 week and upwards) are still showing a down trend, since around November 2011 the MACD on the weekly chart has diverged and is pointing up. So, while there is no entry signal yet for TGA it is one to watch more closely as it looks like it will find support around these level and is entering accumulation and should turn around at some stage.



Will any of this matter in 5 or 10 years time? I guess it depends on the reason you are entering the stock in the first place, and the time frame, but the longer the time frame the less meaningful the technical analysis and the more important the core business performance and analysis IMO.


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