Thursday, May 27, 2010

What Is Intrinsic Value? – 9% Minimum Total Return

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?

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