Value Investing - Calculating Intrinsic Value

Calculating Intrinsic Value  


There are many ways to calculate the intrinsic value.  We'll just go over the most common used PE (Price to Earnings) stock valuation method to calculate the intrinsic value.   Price/earnings ratio is the most common measure of how expensive a stock is.

P/E ratio = P / EPS         P = Current Market Price,        EPS = Earnings per Share

The higher the P/E ratio, the more the market is willing to pay for each dollar of annual earnings. Companies that are currently unprofitable (that is, ones which have negative earnings) don't have a P/E ratio at all.  In general, the P/E ratio is higher for a company with a higher growth rate.Peter Lynch thinks the P/E ratio of any company that's fairly priced will equal to its growth rate.

If we know a stock  P/E ratio and its EPS, we can calculate its value by the following formula:      

Value = P/E * EPS

For example, if stock ABC  long term EPS growth rate is 15%; and next year EPS estimation is $1.8, we can suppose its next year fair PE equal to 15, and its next year’s fair value is 15 * 1.8 = 27. Now that you know what the stock is "worth", you can compare its current stock price with its value to decide if it is worth to buy, sell or hold. For example, if ABC was trading at $20, you would consider it undervalued because its trading at a price that is less than its value of $27. However, if it was trading at $35 per share, it would be considered overvalued. 

http://www.trade4rich.com/Calculation.html

Value Investing - Peter Lynch's Formula

 Peter Lynch's Formula  Peter Lynch 's astounding record makes him the greatest mutual fund manager in history. In his book One Up on Wall Street, Lynch gives a simple, straight-forward explanation as to how he does a quick and dirty valuation of a firm's growth versus its stock price. Here's just a short quote explaining how he does it.

The P/E ratio of any company that's fairly priced will equal its growth rate ... If the P/E of Coca-Cola is 15, you'd expect the company to be growing at about 15 percent a year, etc. But if the P/E ratio is less than the growth rate, you may have found yourself a bargain. A company, say, with a growth rate of 12 percent a year ... and a P/E ratio of 6 is a very attractive prospect. On the other hand, a company with a growth rate of 6 percent a year and a P/E ratio of 12 is an unattractive prospect and headed for a comedown.

In general, a P/E ratio that's half the growth rate is very positive, and one that's twice the growth rate is very negative.

Lynch's formula is as follows:

Intrinsic Value = EPS * G

EPS = Earnings per Share , G = Long Term EPS Growth Rate 

http://www.trade4rich.com/Lynch.html

Value Investing - Benjamin Graham's Formula

Benjamin Graham's Formula   


In The Intelligent Investor, Benjamin Graham describes a formula he used to value stocks. He disregarded complicated calculations and kept his formula simple. In his words: 

"Our study of the various methods has led us to suggest a foreshortened and quite simple formula for the evaluation of growth stocks, which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations."

His formula is as follows:

Intrinsic Value = EPS * (8.5 + 2* G)

EPS = Earnings per Share, G = Long Term EPS Growth Rate

This formula has little practical value to most value investors. A company with an expected growth rate of 10% in EPS could have a P/E (Price/Earnings) of 28.5 to be considered a buy. Most value investors would reject it. However, Graham also preached Margin of Safety. Therefore, taking this formula and allowing a 50% Margin of Safety you arrive at a P/E of 14.25 . Many value investors would take a hard look at a company with a 14.5 P/E growing earnings at 10% a year.

The formula is efficient and simplistic but has its limits:  the model doesn’t work for every stock. It should never be used in isolation. The investor must take into account many other factors such as current asset value, debt to equity ratio etc. 

http://www.trade4rich.com/Benjamin.html

Comment: Warren Buffett thought Benjamin Graham was not at his best when he came up with the various formulae to value stocks.

Value Investing - Warren Buffett's Methodology

Warren Buffett's Methodology  Warren Buffett descends from the Benjamin Graham school of value investing. He takes this value investing approach to another level. He chooses stocks solely on the basis of their overall potential as a company - he looks at each as a whole. Holding these stocks as a long-term play, Buffett seeks not capital gain but ownership in quality companies extremely capable of generating earnings. When Buffett invests in a company, he isn't concerned with whether the market will eventually recognize its worth; he is concerned with how well that company can make money as a business.

Brief summary Buffett's methodology:
1. Has the company consistently performed well? 

Sometimes return on equity (ROE) is referred to as "stockholder's return on investment". It reveals the rate at which shareholders are earning income on their shares. Buffett always looks at ROE to see whether or not a company has consistently performed well in comparison to other companies in the same industry.

2. Has the company avoided excess debt? 

The debt/equity ratio is another key characteristic Buffett considers carefully. Buffett prefers to see a small amount of debt so that earnings growth is being generated from shareholders' equity as opposed to borrowed money.

3. Are profit margins high? Are they increasing? 

The profitability of a company depends not only on having a good profit margin but also on consistently increasing this profit margin. To get a good indication of historical profit margins, investors should look back at least five years. A high profit margin indicates the company is executing its business well, but increasing margins means management has been extremely efficient and successful at controlling expenses.

4. How long has the company been public? 

Buffett typically considers only companies that have been around for at least 10 years. It makes sense that one of Buffet's criteria is longevity: value investing means looking at companies that have stood the test of time but are currently undervalued.

5. Do the company's products rely on a commodity? 

Buffett sees this question as an important one. He tends to shy away (but not always) from companies whose products are indistinguishable from those of competitors, and those that rely solely on a commodity such as oil and gas. If the company does not offer anything different than another firm within the same industry, Buffett sees little that sets the company apart. Any characteristic that is hard to replicate is what Buffett calls a company's economic moat, or competitive advantage. The wider the moat, the tougher it is for a competitor to gain market share.

6. Is the stock selling at a 25% discount to its real value? 

Buffett's most important skill is determining whether a company is undervalued. To do this, an investor must determine the intrinsic value of a company by analyzing a number of business fundamentals, including earnings, revenues and assets. And a company's intrinsic value is usually higher (and more complicated) than its liquidation value - what a company would be worth if it were broken up and sold today. The liquidation value doesn't include intangibles such as the value of a brand name, which is not directly stated on the financial statements.   Once Buffett determines the intrinsic value of the company as a whole, he compares it to its current market capitalization - the current total worth (price). If his measurement of intrinsic value is at least 25% higher than the company's market capitalization, Buffett sees the company as one that has value to buy.

http://www.trade4rich.com/Buffett.html

Our aim as value investors is to find quality businesses at discounts to their intrinsic values.

To Invest or Not to Invest?

When making decisions about a company it is vital to asses not just if they are making profits but if they are generating a suitable return on equity for you, the shareholder. Imagine a business XYZ you invest 10million of your money into it. By the end the year it is made a net profit of 5 million. Pretty good; a 50% return on equity is a business I would like to invest in. Basically this is the golden key to value investing. Avoid the newspapers. This is how I invest and this is what works for me. 

Technical analysis requires to much "if this goes up it will do this" and "if this breaks through it will do this". Regularly I frequently hear analysis say this keyword "IF". For me, I don't like "IF", I like a sure thing. This is why finding good quality businesses, with a proven track record of success is the best way to financial success.

Our aim as value investors is to find quality businesses at discounts to their intrinsic values. 

http://valueinvest101.blogspot.com/2011/03/to-invest-or-not-to-invest.html

What’s Wrong with the Stock Market?

What’s Wrong with the Stock Market?

April 14th, 2009

The problem with the stock market started back before the end of the 18th century—in 1792 as a matter of fact. This was when the stock market as we know it was born under a tree in lower Manhattan. It was there and then that those who first bought and sold stocks as a business got together and formed what became the New York Stock Exchange. From those beginnings, an industry was born that has grown to be one of the most powerful and financially influential in the world.

Transaction-based Compensation – the Wrong Dynamic
Actually, the problem arose from the fact that these people made their money not from any appreciation in the value of the investments they bought and sold but rather from just putting buyers and sellers of those shares together. They profited from the transaction itself. To this day, the majority of brokers receive their compensation as a result of the purchase or sale. It makes no financial difference to them whether their customer gains or loses.

I don’t mean to imply that, just because these people fill a need and are compensated for doing so, they’re bad people. Certainly the existence of this industry is what makes the ownership of stock feasible for the average person. It’s responsible for elevating common stock to the level of liquidity that allows us to own it without fear of being stuck with it when or if we choose to sell it. And it certainly makes it much easier for us to buy those shares when we wish to. If we’re interested in putting our money to work for us in what is arguably the most lucrative manner possible for the least amount of risk, we can’t get along without this industry. But, the difference in perception and fact between what a broker does or is qualified to do and what the uninitiated think he or she is qualified to do is a major source of the problem.

In the beginning, the whole idea of shares was just that: sharing in the fortunes of an enterprise. Where it might be difficult for a company or individual to come up with enough money to finance all that was necessary alone, sharing the business with others in a fashion that limited their liability and exposure to only the amount of money invested was a great way to obtain the necessary funds. Anyone who wanted to participate in a business—sharing both the rewards and the risks—would buy shares and hold them as legal documents that vouched for their entitlement to a proportionate share in the fruits of that enterprise’s operations. Originally, therefore, folks bought shares because they thought the business would be profitable one and they wanted a piece of the action.

The formation of a ready market for stocks, while it performed a very useful service in terms of liquidity and convenience, had a serious side effect. So easy was it to trade that the perception of what a share of stock really was became obscured, giving way to the notion that the stock, like currency, had some intrinsic value that could vary for reasons other than the success or failure of the underlying enterprise.

Easy Trading changed the Nature of the Market
Moreover, the ability to manipulate the perceived value of those shares erected a persistent barrier between those that manipulated it and those that didn’t. It was de rigueur for unscrupulous traders to spread rumors appealing to the fear of the uninitiated, driving down the price of a certain stock, and furnishing an opportunity to pick up a large position at that favorable price. And then it was an equally simple process for those same individuals to spread favorable rumors that appealed to the greedy, drove up the price, and resulted in a great selling opportunity for those who then owned it. Not until well into the 20th century, after the devastating crash of 1929, was there a real effort to address that issue legislatively and make such activities illegal.

However, there was—and is—no way to legislate the greed and fear out of the stock market. Those are still its basic drivers. In fact, as recently as within the last decade, a young kid from New Jersey managed to make nearly a million dollars when he flooded the Internet with glowing stories about a penny stock he had selected for his venture. Unwitting investors bid up the price of the stock with no more to go on than his fiction; and he made a killing.

Disconnect Between Value and Price Creates Bubbles and Busts
The very same dynamics of greed and fear were responsible for an even more spectacular event that impacted millions of shareholders. The appeal of the dot.coms, most of them with no visible means of support—and the technology companies that depended upon them for their burgeoning customer base—inflated one of history’s biggest bubbles. Investors, eager to make a killing, continued to bid up the price of the stock in those companies with no regard for or even any understanding of the factors that comprised their underlying value. This was what the Street refers to as the Greater Fool Theory: “I may be a fool to buy this stock at this price; but I’ll find a greater fool to take it off my hands for more than I paid for it!”

The market of course collapsed when those companies—like Wiley Coyote racing off a cliff only to discover he had nothing under him—learned the hard way that a company had to earn money to live. The extent of that collapse went well beyond rational concerns about the profitability of the affected companies, being exacerbated in large measure by irrational fears growing out of the September 11th, 2001, attack on New York’s World Trade Center and our country’s bellicose activities following that tragedy.

http://www.financialiteracy.us/wordpress/articles/what%E2%80%99s-wrong-with-the-stock-market/

Matters of the Heart - Politics

What is the Present Value of Your Lifetime Income?

Utility of money depends on your whole lifetime wealth.

Do this interesting exercise - Estimate the Present Value of your Lifetime Income.

What is gaining, losing or giving $10,000 or $100,000 today to you when compared to the Present Value of your lifetime income?

Are you rational or irrational in your handling and managing of your finances, work and leisure time today?


[In economics, utility is a measure of satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service but also referring to satisfaction received by its contingent production relations. Given this measure, one may speak meaningfully of increasing or decreasing utility, and thereby explain economic behavior in terms of attempts to increase one's utility. Utility is often modeled to be affected by consumption of various goods and services, possession of wealth and spending of leisure time.]
http://en.wikipedia.org/wiki/Utility

How to Fail: Mark Pincus

By Mark Pincus on April 12, 2012

I’m sometimes called a serial entrepreneur, but that’s only because, before Zynga (ZNGA), I failed to create a sustainable company. After starting two companies in the ’90s, I had a social networking startup, Tribe.net, in 2003. One of the things I try to instill at Zynga is to fail fast, look at the data, and move on, and at Tribe I failed to do that. We came up with ideas purely based on intuition, and it could take us three to six months to build it and launch. Those bullets were expensive, and many of them were not on target. Tribe reached the point where the investors literally gave up, resigned from the board, and walked away. It was just me, my team, and a creditor. We ended up selling the company to Cisco (CSCO) and paying back all that debt.

One thing I learned is that while your vision should never change, you should keep trying different strategies until one works. If you can fine-tune your instinct and have confidence in it, then you can keep taking different bites of the apple and keep approaching the problem in different ways until you get it right. I did that with Tribe, pursuing the social opportunity from multiple angles. I invested in Twitter and Facebook and bought a social networking patent in 2004.

I think failing is the best way to keep you grounded, curious, and humble. Success is dangerous because often you don’t understand why you succeeded. You almost always know why you’ve failed. You have a lot of time to think about it. — As told to Brad Stone

Pincus is the founder and CEO of Zynga.

http://www.businessweek.com/articles/2012-04-12/how-to-fail-mark-pincus

Why College Isn't for Everyone

By Richard Vedder on April 09, 2012

A person who compares the annual earnings of college and high school graduates would no doubt conclude that higher education is a good investment—the present value of the college earnings premium (the better part of $1 million) seemingly far outdistances college costs, yielding a high rate of return. But for many, attending college is unequivocally not the right decision on purely economic grounds.

First of all, college graduates on average are smarter and have better work habits than high school graduates. Those who graduated from college were better students in high school, for example. Thus, at least a portion of the earnings premium associated with college has nothing to do with college per se, but rather with other traits.

Second, a goodly proportion (more than 40 percent) of those attending four-year colleges full-time fail to graduate, even within six years. At some colleges, the dropout rate is strikingly higher. While college students sometimes still gain marketable skills from partial attendance, others end up taking jobs that are often given to high school graduates, making little more money but having college debts and some lost earnings accrued while unsuccessfully pursing a degree.

Third, not everyone is average. A non-swimmer trying to cross a stream that on average is three feet deep might drown because part of the stream is seven feet in depth. The same kind of thing sometimes happens to college graduates too entranced by statistics on averages. Earnings vary considerably between the graduates of different schools, and within schools, earnings differ a great deal between majors. Accounting, computer science, and engineering majors, for example, almost always make more than those majoring in education, social work, or ethnic studies.

Fourth, the number of new college graduates far exceeds the growth in the number of technical, managerial, and professional jobs where graduates traditionally have gravitated. As a consequence, we have a new phenomenon: underemployed college graduates doing jobs historically performed by those with much less education. We have, for example, more than 100,000 janitors with college degrees, and 16,000 degree-holding parking lot attendants.

Does this mean no one should go to college? Of course not. First of all, college is more than training for a career, and many might benefit from the social and non-purely academic aspects of advanced schooling, even if the rate of return on college as a financial investment is low. Second, high school students with certain attributes are far less likely to drop out of school, and are likely to equal or excel the average statistics.

Students who do well in high school and on college entrance exams are much more likely to graduate. Those going to private schools may pay more in tuition, but they also have lower dropout rates. Those majoring in some subjects, such as education or one of the humanities, can sometimes improve their job situation by double majoring or earning a minor in, say, economics.

As a general rule, I would say graduates in the top quarter of their class at a high-quality high school should go on to a four-year degree program, while those in the bottom quarter of their class at a high school with a mediocre educational reputation should not (opting instead for alternative methods of credentialing and training).

Those in between should consider perhaps doing a two-year program and then transferring to a four-year school. There are, of course, exceptions to this rule, but it is important for us to keep in mind that college is not for everyone.


Richard Vedder directs the Center for College Affordability and Productivity and teaches economic at Ohio University

http://www.businessweek.com/articles/2012-04-09/why-college-isnt-for-everyone

Value investing will almost always be right.

How to Play the Market: Irving Kahn

By Irving Kahn on April 12, 2012

No two recoveries are alike. When I came to Wall Street in 1928, I thought the market was crazy. It hit the brakes in ’29. You have to be careful to distinguish between one recovery and the other. You stick to value, to Benjamin Graham, the man who wrote the bible for the market. It’s a mistake to believe you can do more, I warn you. John Maynard Keynes was one of the most famous economists in history. He was a genius, but he failed as a macro investor. It was hard to believe at the time. But when he became a bottom-up value guy, well, he became very successful. With value investing, you don’t have to bend the truth to accommodate periods with derivatives and manias. Value investing will almost always be right.

I’ve seen a lot of recoveries. I saw crash, recovery, World War II. A lot of economic decline and recovery. What’s different about this time is the huge amount of quote-unquote information. So many people watch financial TV—at bars, in the barber shop. This superfluity of information, all this static in the air.

There’s a huge number of people trading for themselves. You couldn’t do this before 1975, when commissions were fixed by law. It’s a hyperactivity that I never saw in the ’40s, ’50s, and ’60s. A commission used to cost you a hell of a lot; you couldn’t buy and sell the same thing 16 times a day.

You say you feel a recovery? Your feelings don’t count. The economy, the market: They don’t care about your feelings. Leave your feelings out of it. 

• Buy the out-of-favor, the unpopular. 
• Nobody can predict the market. 
• Take that premise to heart and look to invest in dollar bills selling for 50¢. 
• If you’re going to do your own research and investing, think value. 
• Think downside risk. 
• Think total return, with dividends tiding you over. 
• We’re in a period of extraordinarily low rates—be careful with fixed income. 
• Stay away from options. 
• Look for securities to hold for three to five years with downside protection. 

You hope you’re in a recovery, but you don’t know for certain. The recovery could stall. Protect yourself. — As told to Roben Farzad

Kahn, chairman of investment firm Kahn Brothers Group, was born in 1905

http://www.businessweek.com/articles/2012-04-12/how-to-play-the-market-irving-kahn

Quantifying Uncertainty and Risk

Learning from and Responding to Financial Crisis I (Lawrence Summers)

Trend Trading Tips for Swing Trading and Day Traders

Trend trading using higher highs and higher lows can be devastating to your account. Here's a more accurate way to trend trade whether you are a day trader or you are swing trading.

Guest Lecture by David Swensen: Investment Management (Yale lecture)

Uploaded by YaleCourses on Nov 19, 2008

Financial Markets (ECON 252)

David Swensen, Yale's Chief Investment Officer and manager of the University's endowment, discusses the tactics and tools that Yale and other endowments use to create long-term, positive investment returns. He emphasizes the importance of asset allocation and diversification and the limited effects of market timing and security selection. Also, the extraordinary returns of hedge funds, one of the more recent phenomena of portfolio management, should be looked at closely, with an eye for survivorship and back-fill biases.

00:00 - Chapter 1. Introduction: Changing Institutional Portfolio Management
03:59 - Chapter 2. Asset Allocation: The Power of Diversification
16:44 - Chapter 3. Balancing the Equity Bias into Sensible Diversification
20:48 - Chapter 4. The Emotional Pitfalls of Market Timing
32:58 - Chapter 5. Survivorship and Backfill Biases in Security Selection
43:17 - Chapter 6. Finding Value Investing Opportunities as an Active Manager
49:02 - Chapter 7. Yale's Portfolio and Results
54:48 - Chapter 8. Questions on New Investments, Remaining Bullish, and Time Horizons

Complete course materials are available at the Open Yale Courses website:http://open.yale.edu/courses

This course was recorded in Spring 2008.

George Soros Lecture Series: Financial Markets

Uploaded by opensocietyinstitute on Oct 11, 2010

The Lecture Series

Open Society Institute chairman and founder George Soros shares his latest thinking on economics and politics in a five-part lecture series recorded at Central European University, October 26-30, 2009. The lectures are the culmination of a lifetime of practical and philosophical reflection.

Soros discusses his general theory of reflexivity and its application to financial markets, providing insights into the recent financial crisis. The third and fourth lectures examine the concept of open society, which has guided Soros's global philanthropy, as well as the potential for conflict between capitalism and open society. The closing lecture focuses on the way ahead, examining the increasingly important economic and political role that China will play in the future.

Learn More and watch the Lecture Series:http://www.soros.org/resources/multimedia/sorosceu_20091112

Behavioral Finance: The Role of Psychology

Uploaded by YaleCourses on Nov 19, 2008

Financial Markets (ECON 252)

Behavioral Finance is a relatively recent revolution in finance that applies insights from all of the social sciences to finance. New decision-making models incorporate psychology and sociology, among other disciplines, to explain economic and financial phenomenon, such as erratic stock price variations. Psychological patterns such as overconfidence and perceived kinks in the value function seem to impact financial decision-making, but are not included in classical theories such as the Expected Utility Theory. Kahneman and Tversky's Prospect Theory addresses such issues and sheds light on irrational deviations from traditional decision-making models.

00:00 - Chapter 1. What Is Behavioral Finance?
09:01 - Chapter 2. Market Volatility: Random, or Socially Influenced? A Present Value Analysis
19:58 - Chapter 3. Overconfidence: Its Ubiquity and Impact on Financial Markets
38:29 - Chapter 4. The Kahneman and Tversky Prospect Theory or, How People Make Choices
58:50 - Chapter 5. The Regret Theory and Fashion as a Measure of the Market

Complete course materials are available at the Open Yale Courses website:http://open.yale.edu/courses

This course was recorded in Spring 2008.

Warren Buffett - The World's Greatest Money Maker

"How to Choose Your Strategy" Presented by Nicole Wachs of TradeKing

Warren Buffett - What is Franchise Value?

For the latest Warren Buffett, go to http://WarrenBuffettNews.com - 

There is much less difference between buying a whole company and buying shares of a company. One difference is that you can change the managers much easier. But if you have to change the managers, then it probably isn't a business that you want to be in anyway. Another advantage to owning 100% is that you can decide how to allocate the excess capital. You can't do that if you only own 5%. At Berkshire, the game is to try to figure out where to put capital. 

Most managers like to grow. They prefer to grow intelligently, but if they can't do that they will try other methods. In the banking industry, they measure themselves by size of their balance sheets, not by profits. Banks don't necessarily have economies of scale beyond a certain point. It is much better to have a large competitive advantage in a smaller market. There isn't much advantage to shareholders for the banks that they own to expand. 

Gillette makes about 2/3 of its money outside of the United States. Companies that can do well in international markets are great. Depending on the different countries they are in, there are many factors that can be better or worse because of tax rates or public opinion. A good business can be found anywhere, but it is easier in the United States if you understand the economy and the business landscape a bit better. 

Franchise value is what a brand has if a customer will leave a store if they don't carry the brand. They would rather walk across the street and pay a nickle more than to buy another brand. That is franchise value, and it is very valuable. It is wholly in the customer's mind. If you've got the right product in that way, you may be paying for taste or something else. The second thing to think about is how durable that franchise value is.