Warren Buffett Intrinsic Value Calculator - Determine if Stock is Undervalued or Not.

Warren Buffett's 4 Rules:
1.  Vigilant Leaders
2.  Long Term Prospects
3.  Stock Stability
4.  Undervalued

Non-Predictable Company (Andrew :-) )

1. Lots of Debt
2. No Long Term Prospects
3. Not Stable
4. Price ? - Can't be determined due to stability

Predictable Company (Linda :-) )

1. Manageable Debt
2. Long-term Prospects
3. Stable 
4. Market Price = $44.33  Intrinsic Value = ?

Lesson Objective 1: How do we calculate the intrinsic value of a stock

Lesson Objective 2: How do we use the BuffettsBooks.com intrinsic value calculator

Summary of this lesson

In this lesson, students learned that the intrinsic value can be defined as the discounted value of the cash that can be taken out of a business during it's remaining life. For us, we've defined the life as the next ten years. This way, we can discount that cash by the 10 year federal note. The Cash that we are taking out of the business is simply the dividends and the book value growth during the next 10 years. Since these numbers need to be estimated, it's very important to ensure that Warren Buffett's third rule (a stock must be stable and understandable) is met.

When a company doesn't have a history of linear growth, estimating the cash that they will produce for the next ten years becomes more speculative. When we look at the root of the intrinsic value calculator, it operates off of the same principals as a bond calculator. Instead of using coupons, we substitute dividends. And instead of using par value (or value at maturity) we estimate the book value of the business in 10 years. The value that we use to discount the summation of the cash is simply the 10 year federal note.

Although the previous paragraph might sound confusing to some, it's application is fairly straight forward. The reason Buffett says, "Two people looking at the same set of facts, will almost inevitably come up with at least slightly different intrinsic value figures," is due to a difference in opinion of the future cash flows. Since some investors are more conservative than others, their estimates of book value growth or dividend payments may be lower. This will immediately change the intrinsic value. Your job as an intelligent investor is to determine your own tolerance for risk and conservative estimates on how much money you will receive while owning the stock for a 10 year period.

Intrinsic Value Calculator

Source of Quotes: http://www.berkshirehathaway.com/owners.html

"Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life." - Warren Buffett

Therefore, the sum of cash that can be taken out of the business over the next ten years is going to be the dividends plus the equity growth. The discounted value is the current value of the 10 year federal note. To start, we'll determine how much a company's book value is growing.

"In other words, the percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value."- Warren Buffett

Click here for the Intrinsic Value Calculator:  

http://www.buffettsbooks.com/intelligent-investor/stocks/intrinsic-value-calculator.html

Related:

Would you rather be with Andrew or Linda? Businesses manage their finances just like individual people. :-)

Would you rather be with Andrew or Linda? Businesses manage their finances just like individual people. :-)

Predicting the future networth of these individuals.

Andrew: Risky to Predict

Linda: Less Risky to Predict



Just because a business has volatile numbers doesn't mean it won't make a lot of money in the future.

It's just more difficult to predict and value = RISK.

Buffett Rule: A Stock must be stable and understandable.

Best Video Explanation of the Yield Curve and how this can help your investing

What is a Yield Curve?

What are the 3 financial risks in an investment?

What causes financial risks in an investment?

1.  Excessive debt
"Only when the tide goes out do you discover who's been swimming naked."  - Warren Buffett. 
Companies incur debts because they want to speed up time.  They can own assets now instead of waiting for them later.  Why is speeding up time a bad thing?
These are often the companies and people with a lot of debts when the market collapses.

2.  Overpaying for an investment.
Price is what you pay.  Value is what you get.  - Warren Buffett
The asset quality has not changed.  The market conditions has not changed.  The poor investment was based on the initial price paid, not the quality of the asset.  The investor overpaid to own the asset or stock.

3.  Not knowing what you're doing.
"Risk comes from not knowing what you're doing." - Warren Buffett.
Why do people value the ownership of a house but not value the ownership of a company?
People understand how to value a house.  Many people do not understand how to value a company or stock.  They definitely do not understand the value of the company when they are broken down into many shares.  So, that is the true risk here and if you are the type of person who buys company shares and never look at what they are worth and buying on the basis that "well I like this company", you are probably setting up yourself up for buying too high above the true value of the share.

Greed and Fear. Who do you think is ultimately determining the market price in the long run?

What are instincts?

Any behaviour is instinctive if it is performed without being based upon prior experience or knowledge.

Since most investors base their investing on emotions and instinct, they follow the mindset of Mr. Market.  (Instinct = without knowledge).

Solution .. become knowledgeable.  Base your decisions on facts opposed to emotions.

Greed Cycle
People are chasing prices ... not value.
Mindset:  A quick buck is about to be made.


Fear Cycle
People are scared they'll lose everything.
Mindset:  I don't k now the value of these stocks, so I'm outa' here.


How do we know how much the stock is worth?  This is a tough question.

The knowledge of a stock's value allows an investor to determine if Mr. Market is Greedy or Fearful.  (That's why we are here.  :-)  )

The key is to be greedy when others are fearful and fearful when others are greedy.  - Warren Buffett.


The name of the game really is between Accumulating Shares versus Trading Shares.  You want to be the person who is accumulating shares.

The stock market behaves like a voting machine, but in the long term it acts like a weighing machine. - Benjamin Graham.

Short Term:   Anyone can price the stock.
Long Term:  The Value becomes absolute.

Who do you think is ultimately determining the market price in the long run?

Benjamin Graham's Mr. Market, a stubborn business partner who sometimes offer great deals or very expensive prices.

As buyers and sellers move the market price of a stock, the market will offer great deals or very expensive prices. This idea is represented by Benjamin Graham's Mr. Market. Graham used the idea of Mr. Market to represent a stubborn business partner that sometimes offers great deals or horrible prices. Your job as an intelligent investor is to determine which deals are of great value.

Benjamin Graham's Mr. Market

Mr. Market is your emotionally disturbed business partner.
You can't change his behaviour  ... but you can react to it!
Mr. Market is your servant, not your guide.

Mr. Market:  "Hey Guys!!!  Buy some stocks ... everyone's make money ... you can too.  I am making a lot of money, so are my friends."

Mr. Market:  "Watch out, I'll take your money.  The outlook for tomorrow is even worse, so don't ask!  If you think you can make money in the stock market, you are just kidding yourself."

Never follow Mr. Market's changing emotions.
Instead, remain calm and competent, and take advantage of the opportunities Mr. Market presents.

Mr. Market is your servant, not your guide. - Warren Buffett

The Reasons for Selling and for Buying a Stock

For every single trade, there is always a buyer and a seller.

The Reasons for Selling

Seller:  "This stock stinks.  I can make more money somewhere else."

Seller:  "I need money for my new car."

The Reasons for Buying

Buyer:  "This company is going to make me some money."

Buyer:  "This company is going to make me some money."

There are a few reasons for selling a stock, but there is usually only one reason for buying a stock.  :-)

The seller thinks the stock stinks, whereas the buyer thinks the company is great.
The seller thinks the stock is still good but he needs the money, and the buyer bought because he thinks the company is great.

Thousands of orders a day cause the market price of a company to move up and down.  However, the market price of a stock is determined only by a small number of players and not by all of the people.

How does the Stock Market work for the Value Investor?

Amy the Seller put a stop order to sell a company share at $65 per share.
Linda the Buyer put a market order to buy.
The transaction was matched.
The market price of the stock is now displayed on the board at $65 per share.


Does this mean the company IS worth $65 a share?

or

Did a couple of people trade it for $65 a share?

As a value investor, the answer is the latter.  The $65 is the trading price.  Just because a couple of people traded the share for $65 a share, this doesn't mean that the company is actually worth $65 a share.

Value investing is all about determining what the value of that share is worth and looking at what the price people are willing to buy it for or sell it for, and capitalize on these.

Why is stock investing so lucrative?

Emotion trading offers really cheap prices and really expensive prices.

Your job is to always calculate the intrinsic value of the business regardless of the size, then compare the value to the price it trades for.

P/E Ratio

P/E Ratio

This ratio is a comparison between the price you would pay to buy a stock and how much profit you may see from 1 share in 1 year.