My definition of intrinsic value boils down to “a wonderful company fairly valued”. By judging 14 value elements I’ll determine if a company deserves this description. It’s my intention to select and buy stocks based on their intrinsic value and to thereby get rich slowly; rich enough, at least, to fund my retirement.
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long term Dividend Income Stream
(13) Increasing Annual Dividends Faster Than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(14) Expect at least a 9% Total Return Compounded Annually
Value element (14) addresses the last of my financial goals; to achieve a minimum total annual return of 9%. I hope to do better, but 9% annual returns are my minimum target.
Total returns are defined by the combination of dividends and capital appreciation. The current dividend yield of a stock is readily available and is used in previously discussed value elements.
To estimate future capital appreciation I’ll use the five year earnings growth constrained by five year revenue growth from value element (2) Strong Earnings Growth to calculate a Compound Annual Growth Rate (CAGR). Then, I’ll add the CAGR and the current dividend yield to estimate the future Total Annual Return Rate (TARR).
Since I insist on a 9% minimum TARR, I won’t consider any company with a calculated TARR less than that. I’ll also reward companies proportionately for achieving a higher TARR score.
Now that I’ve defined all 14 Value Elements I think some of them may be redundant. In the next post I’ll review the list and see if some consolidation is in order.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
Thursday, May 27, 2010
Friday, May 21, 2010
What Is Intrinsic Value? – Dividend Growth Greater Than Inflation
My definition of intrinsic value boils down to “a wonderful company fairly valued”. By judging 14 value elements I’ll determine if a company deserves this description. It’s my intention to select and buy stocks based on their intrinsic value and to thereby get rich slowly; rich enough, at least, to fund my retirement.
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(13) Increasing Annual Dividends Faster than Inflation
Value element (13) is the 4th element dealing with dividends. It’s closely related to (4) Consistent Dividend Increases.
In element (4) I calculate a five year dividend growth ratio. If the ratio (current dividend)/(dividend five years ago) is greater than 1.0 the company passes this test.
In recent years annual inflation rates were in the 3% range. A steady 3% inflation rate corresponds to a dividend growth ratio value of about 1.16; therefore, for a dividend to have just kept up with inflation over the recent five years the growth ratio needs to be 1.2 (rounded up).
To pass value element (13) Increasing Annual Dividends Faster than Inflation, I’ll require a minimum dividend growth ratio of 1.3. Higher is, of course, better.
Just because a company’s dividend payout grew faster than inflation over the recent five years doesn’t guarantee similar performance in the future. But, if the company’s payout hasn’t kept up with inflation it certainly can’t be relied upon to keep up with future inflation.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(13) Increasing Annual Dividends Faster than Inflation
Value element (13) is the 4th element dealing with dividends. It’s closely related to (4) Consistent Dividend Increases.
In element (4) I calculate a five year dividend growth ratio. If the ratio (current dividend)/(dividend five years ago) is greater than 1.0 the company passes this test.
In recent years annual inflation rates were in the 3% range. A steady 3% inflation rate corresponds to a dividend growth ratio value of about 1.16; therefore, for a dividend to have just kept up with inflation over the recent five years the growth ratio needs to be 1.2 (rounded up).
To pass value element (13) Increasing Annual Dividends Faster than Inflation, I’ll require a minimum dividend growth ratio of 1.3. Higher is, of course, better.
Just because a company’s dividend payout grew faster than inflation over the recent five years doesn’t guarantee similar performance in the future. But, if the company’s payout hasn’t kept up with inflation it certainly can’t be relied upon to keep up with future inflation.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
Friday, May 14, 2010
What Is Intrinsic Value? – Reliable Long Term Dividends
My definition of intrinsic value boils down to “a wonderful company fairly valued”. By judging 14 value elements I’ll determine if a company deserves this description. It’s my intention to select and buy stocks based on their intrinsic value and to thereby get rich slowly; rich enough, at least, to fund my retirement.
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long Term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(12) Reliable Long Term Dividend Income Stream
This is the third value element focused on dividends. Obviously dividends are important to me, but how is a “Reliable Long Term Dividend Income Stream” different from (3) Dividend Consistency and (4) Consistent Dividend Increases?
Well, value elements (3) and (4) look at history. Element (12) wants to look into the future. Since I have no crystal ball I can only guess at the future but I’ll make the guess as educated as I can.
Scoring well on value elements (3) & (4) is a baseline. If dividends were inconsistent in the past, I can’t expect the future dividend stream to be better. However, when I measure dividend growth I record the dividends paid five years ago and the current annualized payout. I see, but I don’t record, the intervening three years.
When I look at the five annual payout figures I can easily evaluate the series looking for years without dividend increases, years with dividend cuts, and years with zero dividend payments as well as consistent annual increases. In my analysis, I’ll reward companies that increase dividends every year and progressively punish them for years without increases and for years without payments.
I’m already rewarding companies for being listed in the Dividend Achievers and the Dividend Aristocrats indexes so I won’t consider those measures further.
(11) Measure Risk includes measurements of an earnings based dividend payout ratio (Div/EPS) and a cash flow based payout ratio (CF/Div). These risk measurements are predictors of a company’s ability to pay future dividends.
Another predictor is the consistency of a company’s earnings. In calculating value element (2) Strong Earnings Growth I look at five years of net income. As in the value element (4) I only use the net income from the most recent year and from five years ago.
However, I can also look at the three intervening years and record year over year drops in net income and especially losses. I'll reward companies with consistently increasing net income and punish them progressively for years when income falls and for losses.
“Predictions are hard, especially about the future;” As Yogi Berra said. But, using these criteria I hope to select investments that provide a reliable long term dividend income stream. The remaining risk to my dividend stream I’ll mitigate by maintaining a diversified portfolio of dividend payers.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long Term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(12) Reliable Long Term Dividend Income Stream
This is the third value element focused on dividends. Obviously dividends are important to me, but how is a “Reliable Long Term Dividend Income Stream” different from (3) Dividend Consistency and (4) Consistent Dividend Increases?
Well, value elements (3) and (4) look at history. Element (12) wants to look into the future. Since I have no crystal ball I can only guess at the future but I’ll make the guess as educated as I can.
Scoring well on value elements (3) & (4) is a baseline. If dividends were inconsistent in the past, I can’t expect the future dividend stream to be better. However, when I measure dividend growth I record the dividends paid five years ago and the current annualized payout. I see, but I don’t record, the intervening three years.
When I look at the five annual payout figures I can easily evaluate the series looking for years without dividend increases, years with dividend cuts, and years with zero dividend payments as well as consistent annual increases. In my analysis, I’ll reward companies that increase dividends every year and progressively punish them for years without increases and for years without payments.
I’m already rewarding companies for being listed in the Dividend Achievers and the Dividend Aristocrats indexes so I won’t consider those measures further.
(11) Measure Risk includes measurements of an earnings based dividend payout ratio (Div/EPS) and a cash flow based payout ratio (CF/Div). These risk measurements are predictors of a company’s ability to pay future dividends.
Another predictor is the consistency of a company’s earnings. In calculating value element (2) Strong Earnings Growth I look at five years of net income. As in the value element (4) I only use the net income from the most recent year and from five years ago.
However, I can also look at the three intervening years and record year over year drops in net income and especially losses. I'll reward companies with consistently increasing net income and punish them progressively for years when income falls and for losses.
“Predictions are hard, especially about the future;” As Yogi Berra said. But, using these criteria I hope to select investments that provide a reliable long term dividend income stream. The remaining risk to my dividend stream I’ll mitigate by maintaining a diversified portfolio of dividend payers.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
Friday, May 7, 2010
What Is Intrinsic Value? – Measure Risk
My definition of intrinsic value boils down to “a wonderful company fairly valued”. By judging 14 value elements I’ll determine if a company deserves this description. It’s my intention to select and buy stocks based on their intrinsic value and to thereby get rich slowly; rich enough, at least, to fund my retirement.
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long Term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(11) Measure Risk
Value element number (11) “Measure Risk” comes from Charlie Munger. However, it fits with Warren Buffet’s “Rule #1 – Never lose money.”
There are many sources of investment risk; some of them are:
Political risk – the risk that government action might harm a company’s business performance; for example withdrawing a previously granted oil drilling lease on government land (recently done in the United States by the Obama Administration) or even expropriating a company’s assets as was done to several oil companies by Venezuela.
Management risk – the risk that corporate management will do something stupid, like running a bank at more than 30:1 debt leverage aka Citibank in 2007. This is why Peter Lynch, the acclaimed former manager of the Fidelity Magellan Fund, said he wants to invest in companies that a monkey could run, because eventually one will.
Obsolescence risk – the risk that a company’s primary product or service may be replaced by an entirely different technology; this is the reason the New York Times hasn’t made a profit in years and why “Newsweek” seems to be for sale.
Economic cycle risk – the risk that a company’s revenue and earnings will be strongly affected by the business cycle; with profits in cycle peaks and losses at the bottom of recessions.
Business model risk – the risk that something intrinsic to the business might significantly damage the company’s performance, for example; Causality Insurers are subject to the risk of a serious natural disaster such as a major earthquake or hurricane. Airlines are subject to the risk of flight disruptions from weather and terrorism. Pharmaceuticals are at risk that they'll be unable to develop new drugs to replace revenue lost when a major drug patent expires.
There are probably many other risks, but this list is sufficient for me. Instead of trying to address each type of risk I’ll seek to invest it robust companies that can survive most risks.
To this end value elements (1) Strong Cash Flow, (8) Little or No Debt, (9) Business Model I Understand and (10) A Durable Competitive Advantage are very important. Scoring well in elements (1), (8) & (10) will allow a company to weather many storms.
Scoring poorly in (9) is a red flag warning me that I don’t know what the risks are with this company. I recently sold my positions in two Business Development Companies (BDC’s) as a result of measuring value element (9). I don’t understand the multitude of financial instruments used by BDC’s to invest in their portfolio companies. I find BDC annual reports baffling, so even though I sold them for nice profits I won’t buy them again unless I first learn how they make money.
Dividend Risk
Since I’m primarily a “Dividend Growth” investor I’m concerned with the safety of a company’s dividend payout. Therefore, I’ll measure the risk of a dividend cut with a “Dividend Payout Ratio”. This ratio will be calculated by dividing the annual dividend payout per share by the earnings per share (Div/EPS). I’m already collecting these values in order to measure other value elements. I won’t consider companies with negative payout ratios or ratios greater than 100%. I’ll prefer companies with payout ratios less than 50%.
I’ll also calculate a “Cash Flow Dividend Payout Ratio” by dividing cash flow per share by annual dividends per share (CF/Div). Cash flow per share (CF) is collected for value (1) Strong Cash Flow, so it’s already available. I’ll prefer companies with higher values of CF/Div
There’s no way to escape investment risk. However, by measuring risk (or perhaps lack of risk) and requiring companies I invest in to score well on the risk measurements including dividend risk; I hope to pursue Buffet’s Rule #1 – Never lose money.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
14 Elements in My Definition of Intrinsic Value
(1) Strong Cash Flow
(2) Strong Earnings Growth
(3) Dividend Consistency
(4) Consistent Dividend Increases
(5) Profitability
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(7) Good returns on equity
(8) Little or No Debt
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(11) Measure Risk
(12) Reliable Long Term Dividend Income Stream
(13) Increasing Annual Dividends Faster than Inflation
(14) Expect at least a 9% Total Return Compounded Annually
(11) Measure Risk
Value element number (11) “Measure Risk” comes from Charlie Munger. However, it fits with Warren Buffet’s “Rule #1 – Never lose money.”
There are many sources of investment risk; some of them are:
Political risk – the risk that government action might harm a company’s business performance; for example withdrawing a previously granted oil drilling lease on government land (recently done in the United States by the Obama Administration) or even expropriating a company’s assets as was done to several oil companies by Venezuela.
Management risk – the risk that corporate management will do something stupid, like running a bank at more than 30:1 debt leverage aka Citibank in 2007. This is why Peter Lynch, the acclaimed former manager of the Fidelity Magellan Fund, said he wants to invest in companies that a monkey could run, because eventually one will.
Obsolescence risk – the risk that a company’s primary product or service may be replaced by an entirely different technology; this is the reason the New York Times hasn’t made a profit in years and why “Newsweek” seems to be for sale.
Economic cycle risk – the risk that a company’s revenue and earnings will be strongly affected by the business cycle; with profits in cycle peaks and losses at the bottom of recessions.
Business model risk – the risk that something intrinsic to the business might significantly damage the company’s performance, for example; Causality Insurers are subject to the risk of a serious natural disaster such as a major earthquake or hurricane. Airlines are subject to the risk of flight disruptions from weather and terrorism. Pharmaceuticals are at risk that they'll be unable to develop new drugs to replace revenue lost when a major drug patent expires.
There are probably many other risks, but this list is sufficient for me. Instead of trying to address each type of risk I’ll seek to invest it robust companies that can survive most risks.
To this end value elements (1) Strong Cash Flow, (8) Little or No Debt, (9) Business Model I Understand and (10) A Durable Competitive Advantage are very important. Scoring well in elements (1), (8) & (10) will allow a company to weather many storms.
Scoring poorly in (9) is a red flag warning me that I don’t know what the risks are with this company. I recently sold my positions in two Business Development Companies (BDC’s) as a result of measuring value element (9). I don’t understand the multitude of financial instruments used by BDC’s to invest in their portfolio companies. I find BDC annual reports baffling, so even though I sold them for nice profits I won’t buy them again unless I first learn how they make money.
Dividend Risk
Since I’m primarily a “Dividend Growth” investor I’m concerned with the safety of a company’s dividend payout. Therefore, I’ll measure the risk of a dividend cut with a “Dividend Payout Ratio”. This ratio will be calculated by dividing the annual dividend payout per share by the earnings per share (Div/EPS). I’m already collecting these values in order to measure other value elements. I won’t consider companies with negative payout ratios or ratios greater than 100%. I’ll prefer companies with payout ratios less than 50%.
I’ll also calculate a “Cash Flow Dividend Payout Ratio” by dividing cash flow per share by annual dividends per share (CF/Div). Cash flow per share (CF) is collected for value (1) Strong Cash Flow, so it’s already available. I’ll prefer companies with higher values of CF/Div
There’s no way to escape investment risk. However, by measuring risk (or perhaps lack of risk) and requiring companies I invest in to score well on the risk measurements including dividend risk; I hope to pursue Buffet’s Rule #1 – Never lose money.
Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?
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