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

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.

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

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/

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.

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?

McLovin · 30 March 2012

Depends on the model.

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.

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.

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.

There is a magic formula

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

Focus on the expected value of an investment.

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.

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

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.

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.

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

Cheers

Oddson

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.

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.

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

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.

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

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?

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

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.

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:

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.

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

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.

Cheers

Oddson

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.

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.

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?

Cheers

Oddson.

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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