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.
Example:
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
Showing posts with label Valuation. Show all posts
Showing posts with label Valuation. Show all posts
Tuesday, August 31, 2010
Sunday, August 22, 2010
More on Valuation - Intrinsic Worth
How much are stocks worth? They are worth the present value of their future cash flow. That value is determined by the amount , timing and riskiness of the cash flows.
To calculate the intrinsic worth of a stock, some concepts are needed. First, the discount rate (R) which equal to the time value of money plus a risk premium. The risk premium is tied to factors like size, financial health, cyclicality and competitive positioning of the firm under evaluation. Finally, there is a very long term estimated growth rate of cash flow (g).
To calculate the intrinsic worth, follow five steps:
1) Forcast free cash flo (FCF) for the next 10 years
2) Discount these FCFs to reflect the present value
Discounted FCF = FCF for that year / (1+R)^n
(where R is the discounted rate and n is the year
being discounted)
3) Calculate the perpetuity value and discount it to the present
Perpetuity Value= FCF(n) * (1 +g) / (R - g)
Discounted Perpetuity Value = Perpetuity Value /
(1 + R)^n
4) Calculate total equity value by adding the discounted perpetuity value
to the sum of the 10 discounted cash flows in step 2
Total Equity Value = Discounted Perpetuity Value + 10 Discounted Cash
Flows
5) Calculate per share value by dividing total equity value
by shares outstanding
Per Share Value = Total Equity Value / Shares Outstanding
To calculate the intrinsic worth of a stock, some concepts are needed. First, the discount rate (R) which equal to the time value of money plus a risk premium. The risk premium is tied to factors like size, financial health, cyclicality and competitive positioning of the firm under evaluation. Finally, there is a very long term estimated growth rate of cash flow (g).
To calculate the intrinsic worth, follow five steps:
1) Forcast free cash flo (FCF) for the next 10 years
2) Discount these FCFs to reflect the present value
Discounted FCF = FCF for that year / (1+R)^n
(where R is the discounted rate and n is the year
being discounted)
3) Calculate the perpetuity value and discount it to the present
Perpetuity Value= FCF(n) * (1 +g) / (R - g)
Discounted Perpetuity Value = Perpetuity Value /
(1 + R)^n
4) Calculate total equity value by adding the discounted perpetuity value
to the sum of the 10 discounted cash flows in step 2
Total Equity Value = Discounted Perpetuity Value + 10 Discounted Cash
Flows
5) Calculate per share value by dividing total equity value
by shares outstanding
Per Share Value = Total Equity Value / Shares Outstanding
Thursday, August 19, 2010
Valuation Metrics
When you buy a company stock based on value, you are trying to pay a price based on what you perceive the value of the company plus your margin of safety. Whe you speculate, you are buying stock of a company based on what you think is the probability that there will be a buyer out there who will be willing to purchase your stock at a higher price. In general, SPECULATE at your own risk though I do not deny that occasionally you can make some easy money.
In general, be picky about valuation and do not rely on a single valuation metric because no individual metric can tell the whole story. You may not need to have a finance background ( I don't), but when you start practising how to look at these metrics, you will less likely buy/sell on impulse or hearsay than warranted.
1) For firms that is cyclical or has a spotty earnings history, use price-to-sales (P/S).Companies with P/S ratios lower than their historical average can be bargains sometimes, but pay attention to net margin. In general, firms with higher net-margin warrant higher P/S ratio. In general, industries with higher net-margin tend to be those with higher barrier to entry or wide economic moats.
2) The price-to-book ratio (P/B) is most useful for financial firms and firms with numerous tangible assets but least useful for service oriented firms. In general, firms with typically higher ROE would be worth a higher P/B ratio. For example, my average purchase of DBS is at P/B ratio of 1.07 ( after taking in consideration of the recent $1 billion Goodwill impairment).
3) Compare a company's P/E with the market, a similar firm or the company's historical P/E. Be aware of different growth rates or risks between the companies you are comparing. When comparing with the company's historical P/E, try to understand if the company's macro operating has changed. For example the average P/E of Singtel from 2000 to 2009 is 13.4 (minimum is 8.9, max is 15). My average purchase price of Singtel is at P/E 11.8.
4) Use PEG (PE over growth rate) with caution as fast-growing firms tend to be riskier
5) Check earning yields (inverse of P/E) and cash return (Free Cash Flow over Enterprise Value). Enterprise Value is simply the firm stock market cap plus its long term debt minus cash). The goal is to measure how efficiently the business is using capital (both debt and equity) to generate free cash flow.
In general, be picky about valuation and do not rely on a single valuation metric because no individual metric can tell the whole story. You may not need to have a finance background ( I don't), but when you start practising how to look at these metrics, you will less likely buy/sell on impulse or hearsay than warranted.
1) For firms that is cyclical or has a spotty earnings history, use price-to-sales (P/S).Companies with P/S ratios lower than their historical average can be bargains sometimes, but pay attention to net margin. In general, firms with higher net-margin warrant higher P/S ratio. In general, industries with higher net-margin tend to be those with higher barrier to entry or wide economic moats.
2) The price-to-book ratio (P/B) is most useful for financial firms and firms with numerous tangible assets but least useful for service oriented firms. In general, firms with typically higher ROE would be worth a higher P/B ratio. For example, my average purchase of DBS is at P/B ratio of 1.07 ( after taking in consideration of the recent $1 billion Goodwill impairment).
3) Compare a company's P/E with the market, a similar firm or the company's historical P/E. Be aware of different growth rates or risks between the companies you are comparing. When comparing with the company's historical P/E, try to understand if the company's macro operating has changed. For example the average P/E of Singtel from 2000 to 2009 is 13.4 (minimum is 8.9, max is 15). My average purchase price of Singtel is at P/E 11.8.
4) Use PEG (PE over growth rate) with caution as fast-growing firms tend to be riskier
5) Check earning yields (inverse of P/E) and cash return (Free Cash Flow over Enterprise Value). Enterprise Value is simply the firm stock market cap plus its long term debt minus cash). The goal is to measure how efficiently the business is using capital (both debt and equity) to generate free cash flow.
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