How to Calculate the Intrinsic Value of a Stock like Benjamin Graham! (Step by Step)

Introduction to Calculating Intrinsic Value of Stocks

In this video, the speaker introduces the concept of calculating the intrinsic value of a stock using Benjamin Graham's formula. The speaker explains that understanding intrinsic value is crucial for successful investing.

Understanding Graham's Formula

• Graham's formula is used to calculate the intrinsic value of a stock.

• The formula takes into account various metrics such as earnings per share, price-to-earnings ratio, growth rate, and bond yields.

• By using these metrics, investors can determine whether a stock is undervalued or overvalued.

Building the Model

• To start building the model, create a title for it, such as "Graham's Valuation."

• Choose a specific stock to analyze. In this example, Apple is used.

• Identify the earnings per share (EPS) of the company. This information can be found through financial websites like Yahoo Finance or by using Google Sheets with the Google Finance function.

Metrics in Graham's Formula

• Price-to-Earnings (P/E) Ratio: A metric that indicates how much investors are willing to pay for each dollar of earnings generated by a company. For a no-growth company, Graham suggests using 8.5 as the P/E ratio.

• Growth Rate (G): Represents the expected growth rate of a company over the next five years. Analyst predictions can be found on financial websites like Yahoo Finance.

• Bond Yields: Two metrics related to bond yields are needed - average yield of AAA corporate bonds and current yield of AAA corporate bonds.

Filling Out Valuation Data

• Start by inputting the EPS value for Apple into the valuation model.

• Use 8.5 as the P/E ratio for a no-growth company.

• Determine and input the growth rate based on analyst predictions for Apple.

• Find the average yield of AAA corporate bonds and input it into the model.

• Lastly, find the current yield of AAA corporate bonds and input it into the model.

Finding Earnings Per Share

The speaker explains how to find the earnings per share (EPS) for a stock, using Apple as an example.

Using Yahoo Finance

• Go to Yahoo Finance and search for the desired stock, in this case, Apple.

• Look for the EPS value for the trailing 12 months on the company's page.

Using Google Sheets

• Alternatively, use Google Sheets with the Google Finance function to automatically pull up EPS data. This allows for automation of the valuation process.

Determining Growth Rate

The speaker discusses how to determine the growth rate needed for calculating intrinsic value.

Analyst Predictions

• Visit financial websites like Yahoo Finance and navigate to analysis sections.

• Look for analyst predictions on growth rates over approximately five years.

• Use these predictions as a basis for determining the growth rate in Graham's formula.

Adjusting Growth Rate and Finalizing Metrics

The speaker explains that while analyst predictions are used as a default option, investors can adjust growth rates based on their own judgment.

Flexibility in Growth Rate

• The growth rate provided by analysts is not set in stone; investors can adjust it if they believe it is too high or too low based on their own analysis and judgment.

Completing Metrics Input

• After determining all necessary metrics (EPS, P/E ratio, growth rate, bond yields), input them into Graham's formula to calculate intrinsic value.

Gathering Data and Highlighting Variables

In this section, the speaker discusses the importance of having up-to-date data for calculating the intrinsic value of a stock. They highlight variables in the model that may change in the future.

Gathering Data

• The speaker pulls up official economic data to ensure they have the most recent information.

• They focus on the corporate bond yield, which is currently 2.57.

Highlighting Variables

• The speaker highlights variables in the model that may change in the future.

• Variables such as earnings per share, growth rate, and current yield of triple-A corporate bonds are identified as potential changes.

• Other variables like 8.5 and 4.4 remain consistent with the formula.

Calculating Intrinsic Value

This section focuses on calculating the intrinsic value of a stock using Graham's formula. The speaker explains each step involved in the calculation process.

Calculation Steps

• Start with an equal sign and open parentheses.

• Multiply earnings per share by (8.5 + (17.93 * 2)).

• Close parentheses and multiply by 4.4.

• Divide this value by the current yield of AAA corporate bonds (2.57).

• The result is the calculated intrinsic value of Apple's stock based on Graham's formula.

Margin of Safety and Acceptable Buy Prices

Here, the speaker introduces concepts related to margin of safety and acceptable buy prices for making investment decisions.

Margin of Safety Calculation

• Determine the difference between current price and intrinsic value by dividing current price by intrinsic value.

• Convert this difference into a percentage: 37.58%.

Acceptable Buy Prices

• Multiply margin of safety (65%) by intrinsic value to find acceptable buy prices.

• Based on the data, an acceptable buy price for Apple's stock is 252 or anything below that.

Automating Buy/Sell Decision

The speaker explains how to automate the spreadsheet to determine whether to buy or sell a stock based on the variables entered.

Using IF Statement

• Use an IF statement to create an automated decision.

• If the acceptable buy price is less than the intrinsic value, display "buy."

• Otherwise, display "sell."

Drawbacks of Graham's Formula

This section discusses a drawback of Graham's formula and introduces a revised formula proposed by some investors.

Growth Part of the Formula

• Some investors believe that the growth part of Graham's formula (8.5 + 2g) is too aggressive.

• They suggest using a more realistic price-to-earnings base for no-growth companies: 7 instead of 8.5.

• Instead of 2g as a growth multiplier, they propose using 1g in the revised formula.

Revised Evaluation Formula

The speaker discusses a revised evaluation formula for determining the intrinsic value of a stock. The changes made to the formula are explained, highlighting the impact on the intrinsic value calculation.

Old Formula vs. Revised Formula

• The old formula is presented on the left side, with only formatting changes made.

• The revised valuation formula replaces the price-to-earnings ratio and growth multiplier values.

• The intrinsic value calculated using the revised formula shows a significant difference compared to the original formula.

Impact on Intrinsic Value and Margin of Safety

• The intrinsic value per share using the original formula is $388, while it is $218 using the revised formula.

• Despite keeping a 65% margin of safety, the acceptable buy price based on the revised formula is $141 per share, which is lower than the current price.

• Comparing this with the original valuation, there is a notable difference in determining whether it's an opportune time to buy or not.

Example with Verizon Stock

An example using Verizon stock is provided to demonstrate how both evaluation models can be automated by updating relevant data.

Updating Data for Verizon Stock

• Verizon stock ticker information is entered into both models.

• Earnings per share (EPS) automatically fills in based on available data.

• The projected growth rate for Verizon is found through Yahoo Finance analysis.

Calculating Intrinsic Value for Verizon Stock

Using updated data for Verizon stock, both evaluation models calculate its intrinsic value and determine if it's an appropriate time to buy.

Intrinsic Value Calculation

• With Graham's original evaluation formula, the intrinsic value per share for Verizon stock is $122.

• Using the revised valuation formula, the intrinsic value is calculated to be $84 per share.

• Similar to the Apple stock example, the decision to buy or not depends on which valuation model is used.

Final Thoughts and Considerations

The speaker emphasizes that no valuation model is perfect and encourages a range-based approach for determining intrinsic value. Due diligence and caution are advised when making investment decisions.

Range-Based Approach

• No valuation model can provide a perfect estimate of intrinsic value.

• It's important to aim for a range where the intrinsic value of a stock may fall into.

• Always conduct thorough research and due diligence before making investment decisions.

The transcript provided does not include any additional information or conclusions beyond what is mentioned in the video.