How To Calculate A Stock Intrinsic Value

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.

Intrinsic Value Illustration

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 [2023], 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.

Tomypak Counter

In the previous article, I have shared where to find all the relevant information (http://zayedzulkifli.blogspot.com/2013/04/where-to-find-wtf-investment-tools.html). This will help you to estimate intrinsic value of a stock.

Tomypak Balance Sheet 2012

Tomypak Profit & Loss Statement

Tomypak Cash Flow Statement

Tomypak Cashflow Statement

Don't worry on how-to formula. I have developed excel sheet formula, you just need to plug-in:

1. Current year net profit (from Profit & Loss statement)
2. Total outstanding share in the market
3. Cash and Equivalent (from Balance sheet statement)
4. Total debt (From balance sheet statement)
5. EPS growth rate is standardized though some investment analysts give 26% CAGR-3 years-EPS growth rate. (remember: be conservative)

Tomypak Intrinsic Value

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.

3P: Persistence, 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.

Tomypak EPS Historical

Tomypak Dividend History

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 is just for education purpose. Not intended for buy or sell call.

Investing School of Thoughts

There's a saying, "Tactic wins the battle, strategy wins the war"

To win the investment war, you need to strategize your investment approach. Else, you will have high chance of losing the money. There are 3 popular school of thoughts in investing strategy. There are many more but I just want to highlight 3 strategy that commonly used and successfully generate return as well. The three strategies are

1. Fundamental Analysis Strategy

Fundamentalist will look at the business fundamental, looking at quantitative value at  a report (Ratios, Financial reports like Balance sheet, Cash flow statement, Profit and loss etc) as well as qualitative characteristics of a business - moat, durability, management, business prospects etc.). The fundamentalist will try to buy and hold a stock as long as they can. the buy call will be triggered when a value of a stock is extremely undervalued using margin of safety valuation. The sell call will be executed if the business fundamental is deteriorated like increase of debt, consecutive losses, bankrupt, no durability. Best example in trendy and hot product like Polaroid Camera (now that it is being obsolete in the market), Nokia Handphone use to become market leader in 2000's, now being cannibalized when Apple and Samsung introduced smart phone.

Fundamental vs Technical

2. Technical Analysis Strategy

This strategy will only look at price and volume action. believe that the historical performance of stocks and markets are indications of future performance. This can be tracked using chart and graph. The technical analyst tend timing to buy entry and sell exit based on pattern of price and volume. They sometimes don't call themselves as investors but known as traders or chartists. Sample chart below is MYEG (Company listed in Bursa Malaysia who provides E-Government Services), the arrows are the trigger of buy and sell call. It is not holy grail as they said. Profitability of you being correct is 60-70%.

MYEG stock from the perspective of Technical Analyst

3. Hybrid of Both Strategies

The hybrid of both will only select strong fundamental companies to be traded when there's a buy or sell signal using price and volume action based on historical performance of chart pattern. Some said the hybrid can’t mix as both are opposed to each other like oil and water. The hybrid uses most important reports and ratios like Profit & Loss (earning report), P/E (Price Earning Ratio). Mostly, the hybrid will not try to keep a stock for a long term. Most popular strategy that people talk a lot is CANSLIM Method invented by William O' Neil (Will discuss separately on this in different topics).

Which one should be your choice?

Which one fits your investment objective, time frame, your psychological mind, your full time job etc. Both can be right or wrong. If you think you can consistently make money with either strategies; stick to it, be discipline, have perseverance, patience and may the success be always be with you.

My take (personal bias): is the one who stay in the market the longest and become successful of all time like Warren Buffett, John Neff, Benjamin Graham, Philip Fisher, Peter Lynch, John Templeton (just t0 name a few). Of course, some successful trader like Dan Zanger,  Richard Dennis, William Eckhardt etc. The question is who can sustain longer in the market and becoming more richer. If you look at the Forbes top billionaire, who are they?

Hunting The Value Bargain in Stock Market

Price vs Value

Would you buy a property or land that's worth RM10 million at price of RM100k? May be you think the person who is selling to you is a nutcase. But who would want to sell that if they knew the true value. That's what happening in stock market. Most of the time, the value of a stock sometimes is mispriced. Investor feels that a stock's market price doesn't match the value of the underlying business.

If you remember this famous saying by Warren Buffett: "Price is what you buy. Value is what you get"

I will bring you a real business case example that happened in Bursa Malaysia Stock Exchange recently. Sometimes, we don't really understand why it is being ignored, why investors tend to wait and only take action last minutes. And there are so many question that will make you think, market is really irrational and doesn't make sense.

Example 1: KRISASSETS HOLDINGS BERHAD

Kris Assets (KASSETS) used to own Midvalley Megamall (one of the biggest and crowded mall in Malaysia). They have sold Midvalley to new entity called IGB REIT. From the sale proceed (billion of ringgit) has been returned to Shareholder in the form of Cash dividends and Free unit of IGB REIT shares. Also, KASSETS still has some  amount of cash in bank. To avoid KASSETS from becoming PN17 company (which will give a lot of hassles later to a company), the company must be winding up (de-listed from stock exchange) at a reasonable value.

Kris Assets Value

They have hired liquidator to value delisted price and announced delisted price at RM0.08 on March 26th 2013 (as above). The market price of KASSETS was RM0.05. Huge discount of value 60%. How the market react on this announcement? Nothing! The price only moved on April 2nd to RM0.06. Why investors hesitate to buy at 60% discount of value? The only answer that I know, market is irrational. They only act when market react on the price. The winding exercise will only take 2 months with 60% gain. This is great deal, isn't it? 

Example 2: HUA YANG BERHAD

HUAYANG is one of small capital property developer. If you looked at the below report analysis by CIMB, the land bank owned by HUAYANG against its liabilities, the Revalued Net Asset Value (RNAV) per share  is RM3.96 versus the current market price RM2.03, huge value discount against its market price. This exclude dividend payment around 5-6%. Imagine huge discount.

Huayang Asset Value

What can you understand in the above 2 cases? The above is one of the example on how to value a stock using accounting (balance sheet) valuation. Of course, there are more methods to  value a stock. Sometimes, when you do valuation, a stock can be undervalued or overvalued. The equation is very simple, Undervalue = buy, Overvalue = Sell, Fairly Value = Hold/Wait. Please note that this shouldn't be the only criteria to buy a stock (in certain cases, it can be the only criteria i.e. de-listing of a stock from stock exchange). We will discuss more about the criteria in the future chapters. 

Rule of investing is to buy a stock value that is above its market price. You do not want to overpay the price of a stock that you buy.

“In the short run, the market is a voting machine, but in the long run it is a weighing machine.” —Benjamin Graham (Warren Buffett Sifoo)

Disclaimer: This is only for discussion purpose, not a buy nor sell call.