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
(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

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?

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