Intrinsic Value Calculation

[Jason Lermount]

Hello again, i apologise if this is the improper means by which to ask such a question but i had a question:
I understand that the primary means by which you should value a stock should begin firstmost with analyzing the management, debt, assets etc.
But i was curious what is the raw calculation to calculate intrinsic value, to know whether the stock in mention is even worth consideration at all. I also acknowledge that the means by which one values and analyses a business will influence the value you gather.
But if it is possible, what is the bare boned intrinsic value calculation that Buffet uses, with an example of it in use (if its not too much hassle)
Again sorry, im new to the forums but when i looked around all the other threads on the topic were, well for me at least, quite confusing and my results using the calculation was largely misconstrued from the stock market price.

 

[Boggo]

...

Again sorry, im new to the forums but when i looked around all the other threads on the topic were, well for me at least, quite confusing and my results using the calculation was largely misconstrued from the stock market price.

Don't be sorry Jason, the only stupid question is the one you don't ask. Very helpful mob around here.

Someone will pop up here with a much better explanation to your query than what I can provide.

 

[sptrawler]

I agree 100% with Boggo, always ask, at least you will never die wondering.
From my perspective, the question you have asked is the "holy grail", what is the formula to pick the right stock, if you find it post it on ASF so we can all use it.
There are many ways of valuing a stock, but the two that seem to resonate as the different approaches are, one by technical analysis of price movement and the other by deciding if the company has an underlying value or product that will increase its earnings and value.
If you found a formula, that indicated a gold miner in outer Botswana was a great buy, would you buy it?

Hope I didn't ramble too much, welcome to the forum and enjoy your investment trip.

 

[Jason Lermount]

Don't be sorry Jason, the only stupid question is the one you don't ask. Very helpful mob around here.

Someone will pop up here with a much better explanation to your query than what I can provide.

Thank you very much

I agree 100% with Boggo, always ask, at least you will never die wondering.
From my perspective, the question you have asked is the "holy grail", what is the formula to pick the right stock, if you find it post it on ASF so we can all use it.
There are many ways of valuing a stock, but the two that seem to resonate as the different approaches are, one by technical analysis of price movement and the other by deciding if the company has an underlying value or product that will increase its earnings and value.
If you found a formula, that indicated a gold miner in outer Botswana was a great buy, would you buy it?

Hope I didn't ramble too much, welcome to the forum and enjoy your investment trip.

Thank you for the reply, i was inquiring more as to the raw value, there's a 40 odd minute video of the process on the buffets books website, but it requires the use of their own personal calculator and i'd rather see the equation on a raw mathematical standpoint rather than rely on their website. I understand the importance of understanding the business you're investing into, as well as looking into the assets, debt and management. However, if i were to buy a stock id want to buy it at a price wherein its undervalued rather than overvalued.
Thanks everyone for the replies! it seems like a very friendly, welcoming community here

 

[galumay]

You wont find a single formula that Buffett uses to calculate a range of value for a business, he and Munger have made it clear that they basically assess a business in a few minutes in their heads. No doubt that comes after plenty of reading of the business financials, but the point is they are thinking as potential owners of the whole business and their mental valuation varies with the type of business.

I think you will find most investors have a variety of tools they use to value a business, and generally we end up with a range of value rather than a specific value. (and I would be very wary of anyone who claimed they could calculate an exact valuation!). Many use some form of DCF (discounted cash flow), valuation, given that the definition of value of a business is the total of all future free cash flows, discounted to todays $'s. There are various ways to calculate FCF (free cash flow) and also DCF, they range from very complicated processes including things like WACC and accounting for debt and cash in varying methods as well as consideration of equity risk rates and breaking out maintenance capex. Finally you need a Risk Free Rate and a Margin of Error!

I now use a fairly simplified form of DCF and simply look for a larger margin of error, preferring to be roughly right than accurately wrong!

I also look at ROE & ROIC closely as they inform me about the value of the business also.

I generally dismiss any business with anything other than minimal debt.

I never look at P/E - I find it logically inconsistent to use price anywhere in a calculation of value.

Basically you need to develop your own process that you have a level of confidence in the range of value that it spits out, remembering that the market can fail to agree with your range of valuation for a very long time! You need the confidence in order to have the patience to wait for your thesis to play out.

All of this is just what I have come to believe in my journey as an investor, there are quite different approaches that others have, there are many who have no interest or belief in value and only follow price action, I believe its most important to develop a strategy and style that you follow consistently, although not so tightly held as not to be able to be adjusted as you experience and learn.

Good luck with your journey, I would suggest reading as much as you can about investing to see how the different approaches are structured and see what resonates with you. Also read some psychology and brush up on maths like probability.

 

[Knobby22]

I agree with the above but use a different weighting. The above method works best with established businesses.

I look at the potential growth and the quality of the earnings as the most important factors.
The better the earnings advantages sometimes called a moat the better the business.

I do look at the PE as a measure to assess the present price of the company and whether it is cheap. PE stands for price/earnings but you can't use this on its own.

I would expect a high PE for a high growth company (e.g. CSL) and a low PE for a low growth company (e.g. Telstra).

So for instance Telstra has a PE ratio of 9 with a 3.6% dividend yield which is about right, a low PE does not mean it is cheap. The price is influence by the growth and the dividend. In fact it could be argued Telstra is a bit overpriced. It's definitely not a bargain.

CSL has a PE ratio of 37.9 and a dividend of 1.1% reflecting solid growth. The growth is expected to be about 15% which though quite good probably does not justify the PE ratio. I would want a PE ratio closer to 20. You would expect if the growth rate is to be maintained that CSL would be worth double in 5 years, so you should be paying double Telstra's price probably more as it has better quality earnings (Telstra will probably go backwards) so a PE of about 25 would be a good price to buy.

CSL in the past had a growth rate of around 20% which did equate to a higher PE ratio of about 30 as the price would double every four years not including the increasing dividends. This has slowed as it has become huge.

Two reasons for the heightened price are: poor quality of most companies in the top 50 and lower interest rates which enhance returns.
e.g. If you are confident that you can get 15% a year and interest rates are only 3% then it pays to borrow to buy CSL provided the price keeps increasing.

Traps are whether the earnings are indeed high quality. Supermarkets were considered high quality but the new competitors such as ALDI mean this is no longer the case. Same with CCA (Coca Cola Australia) they have increasing competition and their advantage due to brand recognition is fading.

Growth projections can be false and due to other factors such as abusing their franchisees or fudging figures so you have to be careful.

Debt is also a very important consideration.
Low or no debt is a huge plus unless it is a company like Transurban ( a company I like) which relies on high predictable cashflows and high debt to keep expanding. The moat being a toll road company is strong.

Disclosure:I own CSL, Transurban, I don't own Telstra.

 

[galumay]

Our two posts are a good example of the different approaches even within the narrow field of Fundamental Analysis, I would never use PE to try to assess value, Knobby22 obviously does have a way of incorporating it into his methodology of value assessment.

This is why its important to find your own strategy and process that you have confidence in, and follow it with loosely held, strong conviction!

 

[kahuna1]

Howdy,

As a fundamental investor ... with a bit of a tech tilt as to entry and exit or reduction, the rules of intrinsic value and fundamentals are one which I could fill 20 books about.

Whilst Buffet gets a lot of media, I suggest you ignore a lot of his mutterings, Sure he did well pre 2000 but post 2000 his performance is less than stellar.

His perspective is NOT one easily followed as he has the ability to buy a total business and as a smaller investor one has to merely become a shareholder with limited if any power over the business.

Certainly his comments at annual general meetings are of use, his rules and sharing .... as are Charlies. He however is not my favorite person and whilst he talks a good game on many things like the rich paying more tax, his investments and support for the largest tax avoiders in the USA is on record.

In simple terms, one looks at an industry and say banks and strictly looks from the bottom up on earnings and margins and reserves in minute detail. It becomes obvious what the best run ones are and hence one is able to select the best of the best.

Same with most other industries and business's one is thinking about investing in.

This valuation is something that is covered by many books and people, not something Buffet invented. His books are NOT his books and written by often his family or say media who have little or no idea of how and why to invest.

I prefer say Peter Lynch and his writings and Seth Klarman as learning something. Buffet is more about self promotion in the past 20 years. He sadly is now buying things that, well, like Amazon who never has paid a dividend, never paid tax and rarely makes a profit ... which essentially invalidates most of his preaching about buying stocks and valuation. Amazon much like say Apple or Microsoft for now like Google and Facebook exist as stars by not paying tax to anyone anywhere, which, well .... will end at some stage.

We do have a few top class fundamental investment funds in Australia and Platinum asset management is worth reading their stuff and reports. Magellan Funds Management .... the fund manger there Hamish Douglass ... has done OK is in about the top 1,000- of all fund managers globally ... but of late ... has gone quite strange buying the Tech side with some serious clouds on the horizon via tax issues and USA trade war making China have no choice but to replace all USA software and chips .... his co-founder and the guy who ran the Magellan Fund initially runs MFF capital Investments Chris Mackay and its return is actually in the top 50 of 10,000 funds over the past decade. Prefer his view on things and his displayed performance ....

Fundamental analysis and buying something cheap when stocks are at all time highs is ... not a great time to do it. Of late index funds and basically buying every single stock via an index fund is the latest fad.

Times change and fundamental investing is PATIENCE and often frustrating as say our index and the Banks got shredded late last year and became great value in an overall market I doubted would raise rates in 2-3 years late 2018 ... and we have in fact lowered them, and NOW conversely things that were being shredded across the board are 20.30 and even 50% higher ... and of less intrinsic value up here.

One last thing, my favorite rule and no matter how well you study a company or its books, at times, you will be lied to or misled or make a mistake. IF so, CUT THE BLOODY thing. Take the loss and move on. Taking a 30% loss is better than 80% loss or the company folding or loosing 90% of value. Diversification is the KEY .... not what Buffet preaches, or his silly relations via their books, YES concentrate it but ... to have 25% in one stock idiotic ... UNLESS its a global monster with business's in 50 nations and it MAKES money and PAYS a decent dividend and IT is growing, not growing via tax theft or other silly things going on right now.

Good luck on your journey.

 

[jhmtaylor]

If you go to the website https://www.stock2own.com there is a "free" intrinsic value calculator. They call it the Graham number. The other value price is Rule #1 calculation. In my opinion, neither are worth the effort.

I use a quick and dirty method of comparing P/E to EPS growth X 2. If the growth number is substantially above the P/E number then I will spend some time performing a valuation.

I use a paid site HTTP://www.stockopedia.com to simplify the following tasks.

DCF See enclosed. I often put my own assessment on the growth factors in

Comparison. Then I do a comparison with some comparable peers (See enclosed example)It is very important to understand what the various ratios are and more importantly the story they are telling you about the business. The PEG ratio sometimes is a good indicator of value. Anything with <1 is worth looking at.

Summary Then I review the summary looking for the weaknesses in the business.

If it all looks good then I look at an annual chart with moving averages for 7, 23, 50 and 130 days and MACD for the time to buy-in.

If you have trouble viewing the attachments, use an app that allows you to view them "full size".

 

[jhmtaylor]

Oops I forgot to add.
If I see someone quoting Warren Buffet I don't waste my time reading it because most of the time it is nonsense. In most cases, he has not said what was quoted.

Half the financial journalist like using his name to draw attention to their article to increase their exposure to an otherwise weak article. Journalists who write quality articles don't need to quote Buffet.

The one exception is Buffett's and Munger's letters to shareholders, which are gold.

 

[qldfrog]

Thank you very much


However, if i were to buy a stock id want to buy it at a price wherein its undervalued rather than overvalued.

Think about the above ..does it really matter?
What really matters is what is the price plus any dividend when you sell...
There is no win in being right: it is undervalued...if it is even more undervalued when you sell
Please please think carefully about what i mean..just hope it is clear enough