What is Value Investing?

Posted on December 22, 2008
Filed Under Stock Basic | 2 Comments

Everything has its value. For instance, you would not want to buy a brand new iPhone 8G which is selling with price of $10000 as most likely the gadget is overpriced. You may think an iPhone 8G may cost only $1000. That’s the VALUE you put on it. One month later, the shop is on Mega Sales, and now the same iPhone 8G is selling with super discount price of $500. Are you going to buy it? Of course the answer is yes! That’s definitely a value buy.

Same goes to stocks, they are companies, and they are businesses. Each company has its own market value too. Recently I read a book about value investing written by Phil Town. The author claimed that value investing is all about buying businesses with discount price. The book teaches us ways to evaluate a company by calculation. From the calculation, we get to know the value of a company and thus helping us to avoid buying overpriced stocks. Isn’t it great when we do not have to worry of buying something with high price and selling with low price?

In order to calculate the value (or we call it “Sticker Price” as suggested by Phil Town) of a company, we need to know the current EPS of that particular company, estimated of 10 years EPS growth rate as well as company’s future PE. We perform the calculation based on an assumption of 15% minimum acceptable rate of return.

To calculate Sticker Price, we need:-

  1. Current EPS
  2. Estimated EPS growth rate
  3. Future PE
  4. Minimum acceptable rate of return

Current EPS is quite straight forward, it can be found in most of the share broking site. As for future EPS growth, it is either derived from historical equity growth rate or analyst growth rate. Pick whichever that appears to be lower. Whereas for future PE, it is either default PE, which is EPS growth x 2 or historical PE. Pick whichever that is lower. Again, minimum acceptable rate of return should be 15%, nothing less than that.

A : time (year) to double current EPS = 72 / EPS growth

B : EPS 10 years later = current EPS x 2A

Future Price = PE x B

Sticker Price = Future Price / 4

Here we go, after we get sticker price, we need to calculate margin of safety (MOS) so that we bear as minimal risk as possible.

Margin of Safety = Sticker Price / 2

Example :

Below is  Maybank data:

Current EPS

0.60

EPS growth

25.91

Future PE

8.33

Min return

15

A = 72 / 25.91 = 2.78 (round to 3)

B = 0.6 x 23 = 4.8

Future Price = 8.33 x 4.8 = 39.984 (round to 40)

Sticker Price = 40 / 4 = 10

MOS = 10 / 2 = 5

As at date of writing, Maybank is priced 5.1, it is very near to MOS.

For more details of sticker price and MOS, Rule#1 written by Phil Town or his blog are highly recommended. There is online calculator provided in his blog which facilitates the calculation of sticker price and other growth rates data. All you need to do is just putting in the relevant data and the calculator will do the job for you!

Comments

2 Responses to “What is Value Investing?”

  1. tuneprofit on June 29th, 2009 3:04 pm

    very impressed, RULE#1 student right ?

  2. sachin on December 5th, 2009 10:27 am

    THANK U FOR PROVIDING SUCH THINGS. KINDLY,FOCUS ON RISK PRISM STRATGIES ALSO.

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