My definition of intrinsic value boils down to “a wonderful company fairly valued”. In previous posts I defined 14 value elements describing what I mean by that phrase. Now I’m looking for a better, simpler way to present the elements & the way I use them.
The 14 Elements Value Elements Are:
(4) Consistent Dividend Increases
(6) The Formula: E(2R+8.5)*Y/4 = Intrinsic Value per share
(9) Business Model I Understand
(10) A Durable Competitive Advantage
(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, the 2nd Level, and the 3rd Level analysis. Summarizing the three levels produces the following.
In the 1st Level a company must:
1. Pay dividends with a current annual yield of more than 2.00%
2. Have current earnings that cover the dividend payments
3. Have a forward looking Price/Earnings Ratio (P/E) of less than 16
4. Be favorably viewed by The Motley Fool CAPS community
In the 2nd Level a company must:
5. Generate expected positive cash returns to me above a 9.0% discount rate
6. Have increased revenues over five years
7. Be reasonably priced by the Ben Graham Intrinsic Value Formula
8. Have a Total Annual Return (growth rate plus dividend yield) greater than 8%
In the 3rd Level a company must:
9. Have superior financial performance; low debt; high cash flow, and high returns on equity & assets
10. Have a long term competitive advantage that I can recognize
11. Have a business model that I can understand
This list isn’t much help. It reduces the number of elements from 14 to 11 but more simplification is needed.
Numbers 1 & 2 can be combined into: Generate useful, reliable, and safe dividends.
Number 4 can be dispensed with. I use it but I also override it on occasion.
Number 3 and number 7 can be combined into: Be fairly valued or better at the current price.
Numbers 5, 6, & 8 can be combined into: Extrapolated earnings & dividends growth indicate market beating returns are likely.
Number 9 can’t be combined or ignored. I’ll have to keep it in roughly its current expression.
Numbers 10 & 11 can be stated in a single sentence as: Have a long term competitive advantage and a business model that I can understand.
My restated elements now become:
1. Generate useful, reliable, and safe dividends.
2. Be fairly valued or better at the current price.
3. Extrapolated earnings & dividends growth indicate market beating returns are likely.
4. Have superior financial performance; low debt; high cash flow, and high returns on equity & assets
5. Have a long term competitive advantage and a business model that I can understand.
I can further shorten them to concepts.
1. Generate useful & reliable dividends.
2. Be fairly valued.
3. Market beating returns seem likely.
4. Demonstrated superior financial performance.
5. Has a strategic competitive advantage and business model I understand.
These then, are my revised & simplified value elements. They accurately represent my criteria for selecting the stocks I buy.
The next question is - when do I sell?
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