Your money: measuring the intrinsic value of a stock
By Hemanth Gorur
When something has a high price, it is natural to assume that it has a high value. The investment world works differently. Retail investors tend to chase high-priced stocks, casually unaware that they may in fact be buying a stock of low intrinsic value. Value investing is a school of investing that deals precisely with this phenomenon.
What is the value investing style?
The essence of value investing is to identify stocks that are undervalued by the market and invest in those stocks. The basic premise is that the market has somehow failed to recognize the real or real value of these stocks. Eventually, when the true or actual value of the stock is recognized by the market, the market price of each share of that stock will increase. These stocks are called value stocks. This true or real value of the stock is called the “intrinsic value” of the stock.
Therefore, value investing involves identifying stocks with an intrinsic value greater than its market value and choosing those stocks, usually for long-term investment. Value investors typically realize above-average returns when their value investing strategy pays off.
Measures of a stock’s intrinsic value
Determining the intrinsic value of a stock involves fundamental analysis. Here are some of the often used measures of a stock’s intrinsic value:
1. Book Value Per Share (BVPS): One of the most practical measures is book value per share. The book value of an inventory is given by: Book value = Total assets – Intangible assets – Total liabilities
BVPS = Book Value / Average Number of Shares Outstanding
2. Enterprise Value (EVPS): The intrinsic value of a company can be determined by assessing the value of its assets; i.e. its enterprise value. Since it is difficult to determine it directly, enterprise value can be determined by evaluating the market value of its equity (market capitalization) and the market value of its net debt. Thus, the Enterprise Value of a company goes beyond its market capitalization alone. It is given by: Enterprise Value = Market capitalization + Market value of its debt – Cash & equivalents; where, market capitalization = market value per share (MVPS) x number of shares outstanding
EVPS = Enterprise Value / Number of shares outstanding
A company’s EV can also be determined using the discounted cash flow (DCF) method.
3. Current net asset value per share (NCAVPS): The current net asset value (NCAV) of a company is its liquidation value if it were to be sold. This does not include intangible assets such as patents, goodwill, brand equity or intellectual property.
NCAV = Total Assets – Intangible Assets
NCAVPS = NCAV / Number of shares outstanding
4. Ben Graham Number (BGN): Benjamin Graham, the father of value investing, proposed a measure of a company’s intrinsic value, called the Ben Graham Number, which involves the earnings per share (EPS) of the company. company, and is given by: Ben Graham Number = Square Root (22.5 x EPS x BVPS)
Most of the data needed to calculate these metrics would be available in audited company results or paid research databases.
How to identify undervalued stocks
Value investors can use any or all of the above metrics to identify undervalued stocks. A stock is said to be undervalued if its MVPS is lower than any of the four measures of intrinsic value discussed earlier, or if its MVPS is lower than 67% of its BVPS and lower than 67% of its NCAVPS.
Some restrictions may apply. For example, the BVPS measure may not work well with companies that are not capital intensive. The EVPS measure may require an accurate cash flow forecast if calculated using the DCF method. The BGN metric may need to be changed to reflect what constitutes a “good P/E ratio” and a “good P/B ratio” today.
The writer is the founder, Hermoneytalks.com