as214
184 posts
msg #51561
- Ignore as214 |
5/13/2007 12:27:50 AM
I utilize this formula whenever I want to put a price on something. As far as free financial info I'd use Reuters.com, Ive noticed they have most accurate info. of the free services. Personally, I pay and use VectorVest. It allows me to do an hours worth of financial work in 10 minutes. Ive also noted the values I derive from using this formula are suprisingly consistent with the numbers Vector Vest derives. Also, VV automatically updates Corporate Bond and Inflation rates into their computations. Go to smartmoney.com. Click on "tools" then click on "price check calculator". Plug in your ticker and youll an intrinsic value on your stock but it wont be as accurate as doing the legwork with the formula below.
In "The Intelligent Investor", Benjamin Graham who was also Warren Buffet's mentor, describes a formula he used to value stocks. He shunned complex calculations and kept his formula pretty simple. According to Graham "Our study of the various methods has led us to suggest a foreshortened and quite simple formula for the valuation of growth stocks, which is intended to produce figures fairly close to those resulting from the more refined mathematical calculations."
The formula as described by Graham, is as follows:
Value = Current (Normal) Earnings x
(8.5 + (2 x Expected Annual Growth Rate)
Where the Expected Annual Growth Rate "should be that expected over
the next seven to ten years."
The value of 8.5 appears to be the P/E ratio of a stock that has zero
growth. It is not clear from the text how Graham arrived at this figure, but it
is likely it represents the y-intercept of a normal distribution of a series of
various P/E values plotted against corresponding growth figures.
Graham's formula takes no account of prevailing interest rates; at the time
he last updated the chapter, around 1971, the yield on AAA Corporate Bonds
was around 4.4%. We can adjust the formula by normalizing it for current
bond yields by multiplying by a factor of 4.40/{AAA Corporate Bond Yield}. Bond yields
can be found on Yahoo!
Lets take a real-life example, using IBM. According to Yahoo!, the expected
growth rate for IBM over the next 5 years is 10% per annum (note data is
only available for 5 years ahead rather than the 7-10 years Graham states, but
this should not make a significant difference). EPS for IBM over the last 12
months is $4.95. Taking these values and plugging in the 20 year AA Corporate
bond yield of 5.76% (AA Bond yields are higher than AAA so will give a more
conservative estimate of IV) in our adjustment gives:
Intrinsic Value = 4.95 x (8.5 + (2 x 10) x (4.40/5.76) = $107.77
IBM is currently trading at around $91, so it is currently slightly undervalued.
We can also do the same calculation for IBM's average expected 2005
earnings of $5.62 in order to give some idea of what IBM's price should
be if it meets those earnings estimates:
Intrinsic Value = 5.62 x (8.5 + (2 x 10) x (4.40/5.76) = $122.36
Of course this calculation is somewhat subjective when considered on
its own. It should never be used in isolation - we must always take into
account other factors such as debt/equity, cash flow, management
effectiveness, prevailing economic conditions, etc. Investors should seek
some qualifying criteria such as a PEG (Price Earnings Growth) ratio of
less than 1 in additon to the stock being undervalued based on trailing and
forward intrinsic value. Be aware that PEG itself is also based on future
expectations, so we have to have some degree of certainty that the
company will meet those expectations. We can do this by looking at the
last 5 years growth rate and Earnings figures.
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