Let’s get into the fascinating world of intrinsic value and explore Benjamin Graham’s principles.
What is Intrinsic Value?
Intrinsic value, championed by Benjamin Graham, represents a security’s true worth based on its fundamental attributes rather than market sentiment. Graham’s insight illuminated the irrationality of short-term market fluctuations, emphasizing the importance of a rational valuation approach.
Benjamin Graham’s Intrinsic Value Formula
At the heart of Graham’s contributions lies the Intrinsic Value Formula, an enduring pillar of value investing. This formula equips investors with a systematic methodology to estimate a stock’s intrinsic value. Let’s break it down:
- Earnings per Share (EPS): As the formula’s cornerstone, EPS reflects a company’s profitability per outstanding share after deducting expenses and taxes.
- Expected Annual Growth Rate: This vital element incorporates a conservative estimate of a company’s future annual earnings growth over 7 to 10 years.
The equation, simplified, is:
Intrinsic Value=EPS×(8.5+2×Expected Annual Growth Rate)
Graham’s Approach to Value Investing
Graham’s approach focuses on the concept of an intrinsic value justified by a firm’s assets, earnings, dividends, and financial strength. By calculating intrinsic value, investors can identify stocks trading at a discount to their true worth. Here are some key takeaways:
- Contrarian Thinking: Value investing requires contrarian thinking. While others follow market trends, value investors seek out undervalued stocks that the rest of the market might be underestimating.
- Long-Term Commitment: It’s a long-term strategy that may take several years before generating profits, as stocks need time to reach their intrinsic value.
- Fundamental Analysis: Investors perform fundamental analysis to assess a company’s intrinsic value. This involves examining financials, business models, and other qualitative criteria.
Methods to Identify Undervalued Stocks
Apart from Graham’s formula, there are other methods to identify undervalued stocks:
- Graham Number: A calculation combining book value per share and earnings per share.
- Enterprising Price Calculation: A more aggressive approach that considers a company’s net current asset value.
- Net Current Asset Value (NCAV): Focuses on a company’s liquidation value.
Remember, value investing is about patience, research, and rational decision-making. By understanding intrinsic value, you’ll be better equipped to navigate the unpredictable market landscape and make informed investment choices.