FSM INVEST EXPO 2020
Asked on 18 Jan 2020
What's the criteria/method that you use when valuing a stock?
I only have 2 methods + 1 pre-requisite:
Buy the company for its dividends 👉🏻 use dividend yield method (Google the formula)
💡Determine the yield that you want also you to know the price that you’ll buy this company at
Buy the company for its earnings/cash flow powers 👉🏻 use the discounted method (I.e. over a 10 year period, if I earn $10k each year, should I pay a price of $100k now?)
🔆Pre-requisite: Formulas have always been there. Strangest part is when investors ain’t clear of their intentions of buying the stock. Once I clear this huddle, it’ll a breeze.
Hi Anon! Sounds like you're getting into value investing! Let me refer you to one of the gurus: Warren Buffett. He has mentioned the concept of "intrinsic value" every single year in his annual letters (https://www.berkshirehathaway.com/letters/letters.html). You may find it very instructive to read through them.
Specifically, you may refer to the Owner's Manual (https://www.berkshirehathaway.com/ownman.pdf), page 22. A quick discussion on the intrinsic value.
For dividend stocks, it is the DCF method which is to sum up the total value of cashflows
For stocks that are considered cigar butt investing, it is the relisable net asset value which counts the total value of its asset then discounts its property and receivables minus total liabilities
A lot of people mentioned discounted cash flow. However, it relies on a lot of deep understanding of the business and its future undertakings, prediction, and those predictions actually coming true.
If you are beginner, you should try to do asset based valuation. Simply put, its all the assets (tangible and intangible) minus liabilities. Apart from finance related companies, most traditional businesses can be evaluated using this method first.
My take is that, if you value a company to be worth $1 today, and it is trading at $0.30, if the company liquidates tomorrow, you could be getting a profit even. This requires little to no knowledge as to how to company is going to make its money in future.
It also teaches you to go through annual reports and balance sheets.
Once you are comfortable, then use discounted cash flow methods when you have better understanding of how it's undertaking makes money for the business and sustainability.
Although I mention if the business close shop tomorrow, but that shouldn't be your timeline of investments, a school of thought amongst value investors is trying to invest in a stock for a few years hoping it will unlock value and bring about huge capital gains.
No one will be able to give a definitive answer on valuating a company. Just hope you find one that resonates with your values and you can profit of it.
I mainly use yield because that way provides more margin of safety to beat the market. There are more important factors to stock selection, price is always the first criteria to get me to analyse, and price is always the last criteria to get me to buy. In between, it's a lot of reading and thinking.
Financial-modelling is one thing, but getting the numbers to put it in is another. How would you forecast revenue for the next 5 years, how would you value changes in management and how convincing and accurate it is is the largest consideration, thats how stock pitches are made. Truth be told, to obtain a target price, a lot of numbers that are input are fluff
DCF is the more common ways to calculate intrinsic value. Other methods can be based on P/E, DDM, FCF, RI.
For me, I use EV/EBIT, and I calculate their forward earnings. That would show me the intrinsic valu of the stock. There are other methods like the DCF model as well, but different business would kind of "require" different metrics to look at, for example EV/EBIT would not work for SaaS companies.
Liquidation value : Net Equity = Assets - Liabilities
Long-term value : DCF of future Free Cash flow