Showing posts with label graham's intrinsic value formula. Show all posts
Showing posts with label graham's intrinsic value formula. Show all posts

Monday 6 February 2012

Graham's Valuation Formula

Investing is a multidimensional activity.

To cope with this complexity, investors have resorted to increasingly powerful computers that purport to capture the inter-relatedness of many variables.  But this approach tends to lose the most valuable input of all:  human intuition.

A far better solution for the investment process would be to "freeze" some variables so that analyses could focus on a reasonable number of factors.

Benjamin Graham's valuation formula provided all stock market investors with a critically important tool that freezes one of the key variables of the investment process to simplify the purchase decision.  By using Graham's formula, investors are freed to consider other important factors when evaluating a public company.


GRAHAM'S SIMPLE FORMULA
To calculate intrinsic value, multiply the earnings growth rate by 2 and add 8.5 to the total, then multiply that by the current earnings per share.

[8.5 + (2 x growth) ] x EPS = Intrinsic Value per share

1.  A no-growth company.   The company would have a P/E ratio of 8.5 (and an earnings yield of 12%), which is a fairly typical P/E for a mature company.

2.  An average-growing company.  Most analysts use a P/E range of 15 to 20 times earnings for the S&P 500.  This would translate into the average growth stock in the S&P 500 growing between the ranges of 3.25% to 5.75% (mean 4.5%).


3.  A faster-growing company.  A faster-growing stock growing at 10% will have a P/E ratio of 28.5.  This is fairly typical for the faster-growing companies in the S&P 500.


Two flaws in the valuation models.  All valuation models have flaws.

1.  Models such as Graham's value a company based solely on its earnings.  This leaves out the possible positive effects of non-operating assets or negative effects of non-operating liabilities..  That's why investors need to look beyond earnings and examine company balance sheets prior to purchase to look for non-operating assets and liabilities.

2.  A second flaw has to do with the potential competition from high interest rates.  Should the P/E ratio of stocks be immune to high interest rates?  Of course not.  Graham himself addressed this issue when he suggested that P/E ratios should be adjusted downward if long-term interest rates on AAA corporate bonds
exceeded 4.4%.  The revised Graham formula factors in the current yield to maturity on AAA corporate bonds in the calculation of a company's intrinsic value:

REVISED GRAHAM FORMULA
Intrinsic value per share = EPS x (8.5 + 2g) x 4.4 / y

where,
g = growth rate
y = yield on AAA corporate bonds


If the yields on AAA corporate bonds were to remain at 4.4%, then the original Graham model would remain intact.

If the yields on AAA corporate bonds increased to 6.6%, the P/E ratios would be reduced by 1/3 (4.4/6.6 = 2/3).

If the yields on AAA corporate bonds increased to 8.8%, the P/E ratios would be cut by 1/2.  Thus, the future value of all companies would be reduced by 50%, all things being equal.

For those who want to use Graham's amended model, some caution is warranted.  The model requires that the user forecast interest rates well into the future.  For an investor to rely on recent interest rates as an input to the model could be misleading.


The Intrinsic Value Formula of Benjamin Graham

Intrinsic Value = E (2r + 8.5 ) x 4.4 / Y

E = Earnings
r =  Expected Earnings Growth rate
Y = Current yield on AAA corporate bonds.
8.5 = Graham believed this to be the correct P/E multiple for a company with no growth.

Therefore, Intrinsic Value will rise proportionately to

  • rising earnings, 
  • rising earnings growth rate and 
  • falling yields of AAA corporate bonds.
P/E ratios have risen in recent years, perhaps making 15 to 20 a more appropriate number for a company with no growth, but a conservative investor will continue to use a low multiplier.

Before accepting this formula too enthusiastically, you might reflect on Warren Buffett's response when asked about it.  "I never use formulas like that.  I never thought Ben was at his best when he worked with formulas either," he said with a chuckle.

Monday 17 October 2011

Intrinsic Value Calculator and Spreadsheet Template

http://www.intrinsicvaluecalc.com/


Intrinsic Value Calculator 


Value investors actively seek stocks of companies that they believe the market has 
undervalued.  They believe the market overreacts to good and bad news, resulting 
in stock price movements that do not correspond with the company's long-term 
fundamentals. The result is an opportunity for value investors to profit by buying 
when the price is deflated. (courtesy of Investopedia.com)


Want to estimate the value of a stock? Try this top-rated Intrinsic Value Calculator!


Simply enter your stock symbol and click "Submit" to get started.
Read more about Value Investing



Enter Stock Symbol and click Submit
Enter Stock Symbol  Terms of Use

STEP 1:  

Input values and click "Calculate Intrinsic Value"
Input or Adjust values:
Current EPS (TTM) :Where to find EPS(ttm)?
Estimated Growth Rate to use:%Where to find growth rate?
Future PE To use:View current PE  View historic PEs
Current Price $:Where to find current quote?
STEP 2:  

Review Results
Review Results
Estimated Intrinsic Value Price:$
Estimated Margin of Safety Value Price:$
5-Year Return on Investment Capital (ROIC):
(A strong business will have a 5-Year ROIC of 10% or greater)
  


Review Technical Chart
View Technical Chart for ; trade on momentum [MACD(17,8,9) and 10-day MA] 

Other useful research links:
View Key Statistics for 
View Historic Equity Growth (Book Value / Share) for 
View Historic EPS and Sales Growth for




How is the Estimated Intrinsic Value calculated?
The software determines an estimated growth rate based on the historic EPS and Equity growth rates. It then applies FV (future value) calculations to determine the expected EPS and stock price at some point in the future. It then reverses the calculation using a minimum acceptable rate of return (15%) to determine the intrinsic value in today’s dollars. The MOS price is half of that estimated intrinsic value price. Value investors
believe that risk can be minimized by only investing when the current price falls below the MOS price.




http://www.valuestockmoves.com/spreadsheetinfo.php

Click to Download this FREE!
Intrinsic Value Excel Spreadsheet Template

(or Right-Click and select 'Save-As')







Calculates the intrinsic value and MOS (margin of safety) for your stocks



Additional notes:

If you’re worried about earnings and earnings growth consistency and want to factor it in somehow, you may want to attenuate growth rates or bump up the discount rate to account for uncertainty.

The keep-it-simple-safe (KISS) approach used by most value investors, including Warren Buffett, is to discount at a relatively high rate, usually higher than the growth rate. 

Buffett uses 15 percent as a discount, or “hurdle” rate – investments must clear a 15 percent “hurdle” before clearing the bar.  The 15 percent hurdle incorporates a lot of risk, especially in today’s environment of relatively low interest rate and inflation. Conservative value investors usually use discount rates in the 10 to 15 percent range.




Thursday 5 August 2010

Graham Intrinsic Value video tutorial

Using the Stock Research Pro Software to Calculate Intrsinsic Value Using the Benjamin Graham Formula

Stock Research Pro is a desktop software application designed to guide and streamline the stock research, analysis, and valuation process. The software includes an automated calculator to arrive at a stock’s intrinsic value using the Benjamin Graham formula.
intrinsic_screen
Click here to launch the Graham intrinsic value video tutorial.


http://stockresearchpro.com/graham2

http://www.stockresearchpro.com/benjamin-graham-intrinsic-value-calculator

Tuesday 13 April 2010

Computing Intrinsic Value

Individuals differ from one another in assessing companies' future prospects.  They also differ in their risk tolerance.  Hence, it should be no great leap to accept that there is no unique intrinsic value that can be assigned to a common stock upon which everyone will agree.  

In computing intrinsic value you should start by examining a company's balance sheet.  

  • Some assets, such as cash and investments in marketable securities, are reported at market value.  
  • As a first approximation, the intrinsic value of such items can be taken to be the same as their market values.  


For most companies, however, the major component of intrinsic value comes from their future earnings.
For valuation of future earnings:

  1. You can start with estimating a growth rate based on your evaluation of the company's past performance.  
  2. Then you can apply the estimated growth rate to current earnings to approximate expected earnings for a future year, say, 10 years from the current year.  
  3. Finally, apply a P/E multiple to the future earnings per share to estimate the value of those earnings in the future and discount them to their present value.
  4. In addition, dividends should be properly accounted for.
While it is a simple approach, it requires many assumptions.  For example, 
  • you may have to adjust reported earnings in an attempt to obtain underlying or sustainable earnings. 
  • You also need to assume a growth rate, a P/E multiple, and a discount rate.  
With this approach, it is important to know the company's business well for you to come up with reliable estimates.


Related posts:

Intrinsic value described by Ben Graham in Security Analysis.

Sunday 5 July 2009

Intrinsic Value = (2g+8.5) x EPS

Dissecting Graham's Intrinsic Value Formula


Graham's formula:
V = (2g+8.5) E x 4.4/Y

where,
V= intrinsic value
g= growth rate of earnings
E= current EPS
Y= current interest rate (average rate of high grade corporate bonds)

V = (2g+8.5) x (4.4/Y) x E

V = (Multiple) x E

Therefore the Multiple of E is a multiple of 2 components as illustrated

Multiple = (2g+8.5) x (4.4/Y)

(I) If Y is equal to 4.4
(4.4/Y) = 1
Multiple = (2g + 8.5)


(II) If Y is less than 4.4
(4.4/Y) > 1
Multiple > (2g + 8.5)


(III) If Y is greater than 4.4
(4.4/Y) < 1
Multiple < (2g + 8.5)


As we are presently in a low interest environment, let us assume that Y is equal or less than 4.4. Therefore, the multiple should be equal or more than (2g + 8.5), as in (I) and (II) above.

To be on the conservative side, we can use (2g + 8.5) as the multiple of EPS as a simple quick test to check on the stock's price and true value (intrinsic value).

Simplified Graham's formula:
V = (2g + 8.5) x EPS


EPS can be derived by multiplying [(1/PE) x Price of stock], both are readily available in the local paper.

Reminder: You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.




Graham's Intrinsic Value Formula

Graham did create a very useful and easy-to-use intrinsic value formula.

Graham's formula: You take a current earnings, apply a base P/E ratio, add a growth factor if there is a growth, and adjust according to current bond yield. The result is an intrinsic value that the stock can be expected to achieve in the real world if growth targets are met.

Formula: Intrinsic value = E x (2g + 8.5) x 4.4/Y

E = current annual earnings per share
g = annual earnings growth rate. (Graham would have suggested using a conservative number for growth.)
8.5 = base P/E ratio for a stock with no growth
Y = current interest rate, represented as the average rate on high-grade corporate bonds. (Note that lower bond rates make the intrinsic value higher, as future earnings streams are worth more in a lower interest rate environment.)

Take Hewlett Packard as an example. With current earnings (trailing 12 months) of $2.30 per share, a growth rate of 10%, and a corporate bond interest rate of 6%, the intrinsic value is

= $2.30 x [(2 x 10) + 8.5] x (4.4/6)
= $48.07 per share

This value almost exactly matches the price at the time that these calculations were made. That suggests little potential price appreciation in the stock - unless per share earnings growth accelerates or bond yields dip.

Acceleration in the business would increase the earnings growth rate, and share repurchases would increase the earnings per share. Both changes, especially taken together, would stimulate growth in intrinsic value.

You shouldn't go out and buy or sell stock based on this formula alone, of course, but it's a great "quick" test of a stock's price and true value.