## Thursday, June 24, 2010

### What Is Intrinsic Value? – 2nd Level Calculations – Part 1

My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I defined 14 value elements that describe what I mean by “a wonderful company fairly valued”. Now I’m looking for a better, simpler way to present the value elements & the way I use them.

The 14 Elements Value Elements Are:

(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
(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

In each level of my three level stock analysis hierarchy I test potential stock investments against tougher standards. Each level requires additional data and additional calculations. Previous posts covered the data and calculations of 1st Level analysis and the data required for 2nd Level analysis.

The 2nd Level uses significantly more calculations than the 1st. Today’s post will begin to describe them.

2nd Level Calculations
The Excel workbook that is my stock analysis tool automatically recalculates whenever any formula value changes. So, in reality all calculations at the 2nd Level occur simultaneously. But I will describe them one at a time.

(1) “Dividend Yield” (Yield) as a percentage of the current share price is calculated by dividing the current annual dividend per share by the current share price. This is different from the dividend yield in the 1st Level in that I recalculate this yield each time I update the share price - for some stocks daily; for others it could be more than a year between updates.

(2) A numerical “Score” is calculated by multiplying the “Sales Growth Ratio” by the “Net Income Growth Ratio” & the “Dividend Growth Ratio”. The result is forced to zero if the “EPS Dividend Payout” is negative or greater than 100%. It’s also forced to zero if any of the growth ratios are negative. Exceptions are made for Funds and Limited Partnerships.

(3) An “Internal Rate of Return” (IRR) is calculated assuming that a share is purchased today at the current price and dividends are paid for seven years growing each year at an annualized growth rate (Dividend Growth Ratio/5) and then sold in year seven after appreciating at the same annualized growth rate. The IRR is calculated in a separate tab of the workbook and imported into the 2nd Level tab.

(4) In the same separate tab a “Net Present Value” (NPV) is calculated assuming a purchase at the current share price and the same seven annual dividend payments. A 9.0% Discount Rate is used with a zero salvage value; in other words, it assumes I don’t sell the stock in year seven. The NPV is also imported into the 2nd Level tab.

(5) "Intrinsic Value" is calculated using Benjamin Graham’s formula.

(6) A “Margin of Safety” results from subtracting the “Intrinsic Value” from the current share price.

(7) The “Revenue Constrained Net Income Growth Ratio” (Growth) is the “Net Income Growth Ratio” unless the “Revenue Growth Ratio” is smaller; in which case it’s the “Revenue Growth Ratio”.

(8) A rough “Compound Annual Growth Rate” (CAGR) calculation is imbedded in a formula for the “Total Annual Return” (Return). The Return is simply the sum of the CAGR & the current Dividend Yield.

The remainder of the 2nd Level calculations will be covered in the next post.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

## Thursday, June 17, 2010

### What Is Intrinsic Value? – 2nd Level Analysis Data

My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I defined 14 value elements that describe what I mean by “a wonderful company fairly valued”. Now I’m looking for a better, simpler way to present the value elements & the way I use them.

The 14 Elements Value Elements Are:
(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
(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

I use a three level hierarchy to test each stock; in my previous post I explained the 1st Level.

When a stock passes the 1st Level I collect more data and test it at the 2nd Level and if it passes that test I collect still more data and test it at the 3rd Level. Those that pass the 3rd Level I buy.

Collecting 2nd Level Data
The additional data needed for 2nd Level analysis begins with the current market price. I get the price and nearly all the rest of the 2nd Level data from the MSN Money/Investing/Stocks web site. The price comes from the landing page in the upper left quadrant. Today, For Abbott Laboratories (ABT), the closing price was \$48.63 per share. I enter the price and today’s date in the 2nd Level tab of my stock analysis Excel workbook.

Next I go to the company’s Income Statement by pressing first the “Financial Results” link & then the “Statements” link.

This page, labeled “Abbott Laboratories: Financial Statement”, displays the Income Statement for the previous five years. I then enter the most recent “Total Revenue” number and the earliest “Total Revenue” number in the 2nd Level tab as a calculation; = (newest total revenue)/(oldest total revenue) to calculate the Revenue Growth Ratio.

I scroll down to the “Net Income” line and enter a similar calculation;
= (newest net income)/(oldest net income) as the Net Income Growth Ratio. I scroll down further and pick up the oldest value of “Dividends per Share - Common Stock Primary Issue” and enter it in the “5th Year Dividend” field of the 2nd Level tab. For foreign stocks and ADR’s you must make sure the figures are compatible. Sometimes, the “Primary Issue” is denominated in another currency and sometimes ADR’s are not one for one with the original stock shares. For example, you might find an ADR that represents two original shares; in this case the value of the dividends paid five years ago must be divided by two to make it compatible with the current dividend per share recorded in the 1st Level tab. Because of this problem and the currency problem I generally get the five year old dividend from a five year price chart with dividends displayed.

Then, I enter today’s date to indicate the age of the income statement data. I also go to the Company Report page and record the company’s home country. The “Company Report” link is in the upper left quadrant of most pages in this web site.

The last bit of data needed for the 2nd Level analysis is the current yield on ten year Treasury Bonds (“10-Yr Bond”). This bit is available on the Yahoo! Finance/Investing page as part of the “Market Summary” in the upper left quadrant. I refresh the Treasury bond figure about once a month and use the same figure to analyze all stocks between refreshes.

When the data is entered calculations happen automatically. However, if I’m adding a new stock ticker to the tab I must also add the ticker in two other tabs and copy formulas to the new rows headed by the new ticker. The three tabs are interlinked with each other and with the 1st Level analysis tab.

Next I’ll summarize the calculations performed.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

## Thursday, June 10, 2010

### What Is Intrinsic Value? – 1st Level Analysis

My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I’ve defined 14 value elements that describe what I mean by “a wonderful company fairly valued”. During the process, however, I found some of them redundant or combinable. So, I’m taking another look at my system to find a better & simpler way to present it.

The 14 Elements Value Elements Are:
(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
(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

I’ve designed my stock analysis as a three level hierarchy. When a stock passes one level more data is needed at the next level for a deeper analysis. But the higher analysis isn’t done on a stock unless it passes the previous test. In this way I minimize my time spent acquiring and refreshing data.

Collecting the Data
First level data is pulled from two web pages, both are accessed from MSN Money’s Investing/Stocks landing page, http://moneycentral.msn.com/investor/home.aspx which I’ve set up as a “favorite” in my browser.

When I set up a stock in the 1st Level tab, I enter the US ticker symbol into the “Name or symbol(s)” field in the upper left corner of the landing page and press the “Get Quote” button. I also enter the ticker in my spreadsheet.

As I write this, I’m working through the steps so I won’t leave anything out and I’m looking up ABT, Abbott Laboratories. After pressing the “Get Quote” button, the site brings up the most recent price quote with some summary data.

Next, I copy & paste into my spreadsheet the company’s name as shown on the web page; in this case, “Abbot Laboratories (ABT)”. Then, I scroll down and take note of “The Motley Fool CAPS Rating”. Today, ABT’s CAPS rating is “5”, that is. 5 gold stars are displayed; and I enter “5” in the “CAPS” field of my spreadsheet.

Then, I scroll to the upper right corner of the page and record the annual dividend and the dividend yield from the “fyi Dividend & Yield” field, the EPS from the “Earnings/Share” field, and the “Forward P/E”. I enter all of these in the 1st Level analysis tab. I also enter today’s date so I’ll know when the data was refreshed.

Lastly, I press the “Company Report” link located on the left edge of the page about a third of the way down from the top. This takes me to a page with a general description of the company’s operations and location. It also displays an “Industry” field that defines an industry sector. For ABT, the “Industry” is “Drug Manufacturers – Major”. I use this information to classify the stock by sector and I record the sector in the spreadsheet.

That’s all the data I need at the 1st Level. When, eventually, I refresh the data the ticker, company name, and sector will seldom need updating so, normally, I just collect the CAPS rating, dividend, yield, EPS, and forward P/E from the “Quote” page and, of course, enter the new date.

1st Level Analysis
The analysis is very simple and contained in two cells per stock record (one line on the spreadsheet).

In one cell I calculate an EPS based Dividend Payout Ratio. In the other cell I screen the data elements.

The screening formula requires:
(1) The CAPS rating to be greater than “3”
(2) The Dividend Payout Ratio to be less than “100%”
(3) The EPS to be greater than “0”
(4) The Forward P/E to be less than “16”
(5) The Dividend Yield to be greater than “2.00%”

Exceptions are made for stocks with a “Sector” classification of “Fund” or “MLP”. Ticker symbols with these classifications automatically pass the 1st Level test.

Individually, these screening requirements don’t seem very strenuous but, taken together; they eliminate about 80% of the stocks I consider.

Next I’ll look at the 2nd Level Analysis.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?

## Thursday, June 3, 2010

### What Is Intrinsic Value? – Reconsidering Value Elements

My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I’ve defined 14 value elements that, taken together, describe what I mean by “a wonderful company fairly valued”. During the process of precisely defining the 14 value elements, however, I found some of them redundant and others possibly combinable. So, I’m taking a second look at my analysis system - a system that resulted from developing the 14 value elements - and see if there is a better & simpler way to present it.

The 14 Elements Value Elements Are:
(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
(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

I’ve divided my analysis into three levels. The first level is a screen. Every stock I find of interest I add to my Excel workbook and test against the screen. As I write this there are 1,324 stocks and funds listed in my first level analysis tab. This screen requires a minimum of data which is important since I enter all of the data manually. Today, 251 ticker symbols pass the first screen.

Stocks that pass the first screen are tested at the second analysis level. Of the 251 stocks & funds that pass my first analysis 230 are set up in the second level. I haven’t yet set up the other 21 but I will eventually. The second analysis requires twice as much data as the first, but when those data are entered I get an immediate pass/fail signal; those that pass I take directly to the third analysis level.

The data required for the third level is about equal to that required for the second. Sixty-three stocks & funds have been subjected to the third level analysis to date. Of those, 22 pass. They are my “Buy” list. Seventeen others are close enough to passing that they make up my “Watch” list.

In my second level analysis tab I enter daily prices in a semi-automatic way for my “Buy” & “Watch” list stocks. Prices affect the calculations in both the second & third levels. So, price swings sometimes move a stock from the “Watch” list to the “Buy” list and vice-versa.

Next post, I’ll run through the first level analysis in some detail.

Link to Other Topics in the Get Rich Slowly Report: What Is Intrinsic Value?