In the previous articles, we have covered on buying a stock that is below its market value. There are 1001 ways on how to define an intrinsic value of a stock. As you know, stock market price is fluctuated every now and then. You will never know at what price that market reflects a stock true value.
I will share on how to come out with intrinsic value. I may not be possible to cover all methods of the stock valuation in one article but will try to cover it as many as I can in the next series of articles.
Just remember, calculating an intrinsic value is not an exact science. It is a projection or estimation on the future value of a stock price based on business historical performance. What determine a future value is subject to a lot of factors, variables and parameters:
- Business performance – can a company sustain its current performance in the next 10 years?
- Business trend – Will the trend change? (best classic example, Nokia used to be a leader in Cellular phone but it has been knocked down once Apple Inc. introduce Iphone. Now Apple Inc. faced the same cycle where Samsung has slowly become No.1 in Smart Phone Industry)
- Economic condition (country, regional and global)
- Company’s financial condition (debt, cash flow, Earning, future expansion and capital expenditure etc)
- Talented CEO or Board of directors
For the above criteria, you need to be really conservative in your stock valuation. One of the stock investor legend (Benjamin Graham and Seth Klarman), they factor in the so-called Margin of Safety (MOS). On the other hand, coming out with Stock Intrinsic Value, it is an estimation. Famous saying by Warren Buffett, “It is better to be approximately right than precisely wrong.” An intrinsic value of a stock will give a hint or gut feeling whether a stock value can be undervalued or overvalued.
Why do we bother to find an intrinsic value? Here’s the reason why. Assuming a company’s earning growth 15% on yearly basis. Current Earning is RM100 million. Next 10 years, if a company accumulated RM100 million every year, by year 2023 company has accumulated RM1 billion. Next step is, in the next 10 years , will the value of RM1.00 in 2023 be equivalent to RM1.00 in 2013. You never know what is the inflation rate like, interest rate, BLR rate etc. What do you need to do? You need to factor in Discounted rate.
Let’s use a real company information and come out with intrinsic value. I choose Tomypak Holding Berhad.
In the previous article, I have shared where to find all the relevant information (http://www.investmentmalaysia.org/2013/04/where-to-find-wtf-investment-tools/). This will help you to estimate intrinsic value of a stock.
Don’t worry on how-to formula. I have developed excel sheet formula, you just need to plug-in:
- Current year net profit (from Profit & Loss statement)
- Total outstanding share in the market
- Cash and Equivalent (from Balance sheet statement)
- Total debt (From balance sheet statement)
- EPS growth rate is standardized though some investment analysts give 26% CAGR-3 years-EPS growth rate. (remember: be conservative)
Tomypak current market price as of last week was RM1.41. Comparing its intrinsic value RM3.04, our entry price should be at RM1.52 or below (the lower the better it is). So, does that mean when we buy RM1.41 we will immediately get RM3.04? It will take time for the market to realize tomypak market value. if lucky enough, we may see the realization in 2-3 years. To be successful in investing, you need to have 3P Persistent, Perseverance and Patience.
Some additional information on Tomypak. On top of margin of safety price, a dividend will be a safety net for your investment while waiting for market to realize a stock value. At least, you have passive income plus capital appreciation.
Another factor to decide:
- A company has been consistently and continuously paying dividends to stock holder
- A company has recorded uninterrupted net profit for many years
- A company’s operating cash flow
- Proven record on ROE (Return on Equity) that company has efficiently used capital and provide reward to shareholders.
- Conservative debt management – net cash is preferred
Disclaimer: The above article is just for educational purpose. Not intended as buy or sell call recommendation. Please do you own analysis before investing.