Tuesday, August 31, 2010

Benjamin Graham's Valuation method

In his book, The Intelligent Investor, Ben Graham provides an alternative straight-forward formula for calculating fair value of 'growth' stocks.

This formula is intended to produce results similar to those from more refined mathematical calculations such as discounted cash flow (DCF) calculations.

His formula is:
Intrinsic Value = Current (Normal) Earnings x (8.5 + twice the expected annual growth rate)

He discounts the intrinsic value to provide a margin of safety. He suggests that the growth rate should be that expected over the next seven to ten years.

Take Singtel (EPS : 24.55)
Very difficult to estimate growth rate but considering it is in a mature industry, let be very conservative, take annual growth rate to be 2%)
So, intrinsic value = 24.55 * (8.5 + 2*2) = 3.07
This a very rough estimate, but it give me confident that whenever Singtel drop below 2.8, I will start to buy progressively..
 Take StartHub (EPS : 18.68)
Let take growth rate to be 1.5% since StartHub only operate in Singapore so growth rate should be lower than Singtel

So, intrinsic value = 18.68 * (8.5 + 2*1.5) = 2.15

Again, I will consider buying in when StartHub is below 2.15 since StartHub business is probably more stable than Singtel due to the lack of overseas exposure.

Why do I choose Singtel and Starhub for this analysis. It is because Telcos business is inherently more defensive and stable relative to others. So the earning figures we use should be relatively more reliable. However, you do need to watch out from for major trends in telecommunications as mature business can undergo decline eg postal services

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