## Thursday, July 1, 2010

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

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 that phrase. 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 previous posts I explained the 1st Level analysis, 2nd Level data collection, & began explaining the 2nd Level calculations continued here.

The remaining 2nd Level calculations screen my previously described results against a minimum standard; they apply weighting factors to rank the survivors. Each result is used to assign a parameter value.

To screen out the results that are below the minimum standard, I set the parameter value to zero. Some parameters are binary – their only possible values are zero or one. Other parameters have possible values greater than one.

When all parameters are multiplied together a meta-parameter is created. If any parameter is zero the meta-parameter is also zero. If all parameters are greater than zero the meta-parameter is relatively higher as more parameter weighting factors are employed. The meta-parameter determines whether or not the stock passes the 2nd Level test.

Parameter values are listed below.

“ScoreParameter” = 0 if Score is less than or equal to 0.5; = 1 if Score is between 0.5 & 30; = 2 if Score is greater than 30

“IRRParameter” = 0 if IRR is less than or equal to 0; = 1 if IRR is greater than zero but less than or equal to 30%; = 2 if IRR is greater than 30% buy less than or equal to 60%; = 3 if IRR is greater than 60%

“NPVParameter” = 1 if NPV is less than or equal to \$0; = 2 if NPV is greater than \$0 but less than or equal to \$100; = 3 if NPV is greater than \$100

“CAPSParameter” = 1 if CAPS is less than or equal to 4; = 2 if CAPS is greater than 4 (5 is the only allowable value of CAPS greater than 4)

“AchieversParameter” = 1 if the stock is not listed in the Dividend Achievers index or in the Dividend Aristocrats index; = 2 if it is listed in either or both indexes

“SalesGrowthParameter” = 0 if the Sales Growth Ratio is less than or equal to 1; = 1 if the Sales Growth Ratio is greater than 1 but less than or equal to 2; = 2 if the Sales Growth Ratio is greater than 2

“SafetyParameter” = 0 if the Margin of Safety is less than negative 50%; = 1 if the Margin of Safety is less than 0% but greater than negative 50%; = 2 if the Margin of Safety is greater than or equal to 0& but less than 20%; = 3 if the Margin of Safety is greater than or equal to 20%

“ReturnParameter” = 0 if the Total Return is less than 8%; = 1 if the Total Return is greater than 8% but less than or equal to 20%; = 2 if the Total Return is greater than 20%

“FlagParameter” = 0 if the stock fails (right now) the 1st Level test; = 1 if it passes the 1st Level test

These parameters are multiplied together to produce the meta-parameter. If the meta-parameter is greater than or equal to 16 (an arbitrary cut off) the stock passes the 2nd Level Analysis test.

It’s then subjected to the third and final level of analysis – the subject of the next post.

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