Simple Valuation Method- I

In this article I am suggesting a very simple method to find intrinsic value. Any novice can do this valuation. It’s not a fool proof method and may have downsides, but this method does give a reasonable down target to buy stocks.

Step 0

  • Do the ground work. You have to pick a target based on historical analysis, future potential, qualitative aspects etc..

Step 1

• The first step is to find the EPS-GR.

• Based on the EPS growth rate, calculate the expected EPS.

Step 2

• Estimate the future P/E

• Calculate the estimated future price by : EPS x P/E

Step 3

• From the future price, calculate the present vale of the stock.

• Use the concept of margin of safety to compensate all the errors  in valuation.

• Compare the stock price with the current market price

Step 4

• Invest, if you find the stock’ price less than what you got in step 3

• Else, wait for the stock to fall.

EXAMPLE

Let’s take the case of ICICI bank which has an EPS and PE as follows:

(Source: Moneycontrol.com)

• 2007 -Rs 34.50, PE 26

• 2008 -Rs 37.37 , PE 21.40

• 2009 – Rs 33.76 , PE 10.27

• 2010 -Rs 36.10 , PE 27.51

• 2011 – Rs 44.73 , PE 25.90

STEPS

Step 1:

  • The EPS CAGR would be 6.7% The estimate for 5 years hence at 6.7% growth rate would give a target EPS of 61.86.

Step 2:

  • The average P/E for the last 5 years would be 22.21So, expected share price in 2016 = 61.86 x 22.21 = Rs 1373.

Step 3

  • Rs 1373 is what we expect in 2016. The next step is to calculate the present value of the stock, that is, what is the comfortable price now. For this, we need to know what the average inflation rate is. Let’s assume that it is 8% on an average.
  • So, the present value of Rs 1373 discounted at 8% inflation rate would be Rs 934.00

Step 4

  • Applying the margin of safety: Warren buffet recommends buying shares at 2/3rds of the intrinsic value. That’s a 66% down target. Let’s put a margin of safety of 35%.
  • Rs 934 x 65% = Rs 607
  • We get Rs 607 as the intrinsic value . Instead of a correct price, we may set a target range between 30-40% of the intrinsic value as our entry point.

Recommended Buy range

  • The recommended range would be between - Rs 560-653.
  • The beta value of ICICI bank according to the BSE is 1.41. It’s a volatile stock. So, a small drop in stock markets may give better chances  to accumulate the stock at our target rates.
  • ICICI bank hit Rs 641 on Dec 19th, 2011.
  • Anybody who patiently waited for this catch in 2011 would have easily picked up the stock at Rs 650 + levels.
  • Today when I’m publishing this, the stock has opened at Rs 952. That’s an average of 45% jump in just 2 months.

If we follow Buffets method:

  • We would target 66% down
  • The book value of ICICI bank as on march 31st is 478.31.
  • Rs 934 x 34% = Rs 317 is the buy target which is below the book value.

Let’s check the results-

  • August 2011- Bank of America-Merrill Lynch has recommended to buy ICICI at Rs 873 with a target of Rs 1200 in future.
  • November 2011- Dalal street investment journal has recommended to buy the shares in a ‘staggered manner’
  • August 02, 2011- India Infoline research desk had recommended to buy at Rs 1021
  • August 02, 2011- Gaurav Doshi, VP Equity Specialist, Morgan Stanley PWM, had commented in economic times Aug 2 2011 issue that he is bullish on the stock and he would accumulate the stock at ‘reasonable levels’.
  • Nov 03, 2011 – way to wealth in it’s research report recommended ‘buy’ with a target of Rs 1153
  • Oct 25 2011- A C choksi in it’s research report recommends ‘buy’ at Rs 892.
  • Oct 24 2011- Emkay securities in it’s Diwali special recommendation rated ‘accumulate’ for Icici bank at Rs 852 or below.
  • Feb 8 2012- India Infoline recommends ICICI at Rs 906-908
  • Feb 8th 2012- Motilal Oswal recommends ICICI with a target of Rs 1100

That’s one value method for you. Simple and effective. It doesn’t require much knowledge in finance or accounting and anybody from any stream can do this with a bit of effort.

A word of caution

This valuation method is effective only in fundamentally good stocks, especially large caps. You might need a higher margin of safety while applying this technique.

The default method of valuing stocks is not this one. It’s called DCF method or discounted cash flow method. I will explain DCF method in my next set of lessons targeted at intermediate users.

You may like these posts:

  1. Estimating the P/E
  2. 5 Investment concepts
  3. Sources to pick stocks for valuation.

20 Responses to “Simple Valuation Method- I”

Mansoor

February 15, 2012 at 10:50 pm

This is an excellent article. Simple, to the point, explains well with an example, and I am no finance graduate but understand this very basic method. Awesome. Can’t wait to go through the DCF method which I failed to understand in the past.

killivalavan

February 16, 2012 at 10:00 pm

So, the present value of Rs 1373 discounted at 8% inflation rate would be Rs 934.00

It should be 1271 i suppose

J Victor

February 17, 2012 at 7:18 am

Eps target for 5 years is 61.86 . Rs 1373 at 8% for 5 years = Rs 934.

Rs 1271 is the present value for 1 year .

If you are calculating for a year, you should also revise the EPS estimate for 2012 at 6.7 growth rate.

nikhil

February 27, 2012 at 9:50 pm

how to find last 5 year pe ratio

J Victor

February 28, 2012 at 9:35 am

The information about P/E in this example has been taken from money control .

Check the following link : http://www.moneycontrol.com/financials/icicibank/ratios/ICI02#ICI02

Sachin

April 6, 2012 at 9:58 pm

I dont see any PE value in above mentioned link.. Do we need to calculate from 2 terms? in PE ratio P is market price… Which value to consider in whole year for this formula?

J Victor

April 7, 2012 at 7:39 am

we’ve taken the average P/E.

read these two links to understand more on P/E.

http://www.sharemarketschool.com/price-to-earnings-ratio-or-pe-ratio/

http://www.sharemarketschool.com/the-nuts-and-bolts-of-pe-ratio/

Sachin

April 7, 2012 at 10:16 am

Thanks for quick reply

I have gone through above 2 links. Those explain very well about PE ratio

In this article you have taken PE from 2007 to 2011

2007 -Rs 34.50, PE 26
2008 -Rs 37.37 , PE 21.40
2009 – Rs 33.76 , PE 10.27
2010 -Rs 36.10 , PE 27.51
2011 – Rs 44.73 , PE 25.90

Are these ready made values in http://www.moneycontrol.com/financials/icicibank/ratios/ICI02#ICI02.

In one link about PE, it says “The commonly used time-frame to calculate price-earnings multiple is the trailing 12-month period.”. Could you please explain me by taking below example for year 2007?

2007 -Rs 34.50, PE 26

nikhil

April 7, 2012 at 8:37 pm

go to moneysighths.com There you find last 7 year p/e and eps ratio below at left hand site.
choose any stock and at the below left hand site there is financial and shareholding trends
there you can see all ratos.

Prasad

May 23, 2012 at 12:02 pm

Thanks for your informative blog. I am just getting the type of information i need. right basics.

Manish Patel

November 22, 2012 at 12:42 am

HI Victor. Thanks for the article. I think you have taken 5% inflation instead of 8% in your calculation for ICICI’s case. 8% inflation for 5 years would bring Rs.1373 down to Rs. 904.91.

J Victor

November 23, 2012 at 9:26 am

dear manish,

i have used 8% inflation rate ( or discount rate ) for a period of 5 years. The calculation is right. You might have done something wrong in your calculations. At 5% discount rate the answer would be 1075.

Akshay

November 29, 2012 at 11:24 am

Hello Victor,
I am still not getting the Past P/e values from money control or any other site.
Could you pl. help

url.org

December 31, 2012 at 1:18 am

Heya i’m for the first time here. I found this board and I find It truly useful & it helped me out much. I hope to give something back and help others like you aided me.

Anonymous

February 16, 2013 at 9:44 pm

Having read this I believed it was really informative.
I appreciate you spending some time and energy to put this article together.
I once again find myself personally spending way too much time both reading and leaving comments.
But so what, it was still worthwhile!

nipun

April 18, 2013 at 2:00 am

very informative keep it up

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May 26, 2013 at 5:39 am

Superb Webpage, Keep up the useful work. Thanks a ton!

VenkatRajesh Allem

May 26, 2014 at 7:48 am

Hello Victor,

I know I was very late in getting to your website and reading through all the articles since last two months and finally I have arrived at this post.

This is the first time I was seriously looking at investing in share market.
I was told about your website through my friend.
I really admire the way you write your articles to make even novice individual to understand better.
So, accept my best wishes to you for such a commendable passion to write with simplicity.

I was trying to use the example of ‘ICICI bank’ shown in this article.
when I tried to calculate the EPS-CAGR, I am getting 6 only instead of 6.7 (as you mentioned) (I used excel spreadsheet).

Please correct my steps and point me where I made mistake.

1. Growth Multiple = 44.73/33.76 —> I get 1.32
2. Using the ‘Power’ function of excel : =Power(1.32,1/5) —–> I got 1.06
3. subtacting 1.06 from 1 —–> I got 0.06
4. Multiplying 0.06*100 –> I got 6 (EPS-CAGR)
5. Estimated EPS for 5 yrs –> I have used (44.76+44.76*0.06) and I have repeated this for next 4 years as well with each of the yrs output, finally I got 59.86 (whereas you got 61.86)

Please correct my understanding and calculations.

Best regards,
Rajesh

J Victor

May 26, 2014 at 9:46 am

hi
1. Growth multiple is calculated as 44.73/34.50 = 1.29

2. Since 5 years data is used, you can calculate EPS CAGR for 4 years only. If you use power function you’ll get 1.06573. I did it manually and got 1.67

3. I have repeated the calculation 5 times to reach 61.86

This example was to give you an idea about how things are done. Ideally you must crunch 8 or 10 years data precisely

VenkatRajesh Allem

May 26, 2014 at 10:51 am

Wow !,
Thank you so much for a lightning fast response.
Now I am clear in understanding.
Yes, as you mentioned I was trying to see if I get same numbers based on example, so that I can devise some automated formulae for future data crunch.
So, if I look for 10 yrs data, I should take only the 9 yrs data for calculations of EPS CAGR?
Clarify this alone.

Thank you once again.

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