Intrinsic problems with Intrinsic value…
I often read about the various methods deployed to calculate an “Intrinsic Value” of a share and it makes me wonder why anyone would even try. I really wonder if it is worth my while (and my time) to gather together the numerous variables and financial data which will impact the future worth of a business. Take this data make some rather broad assumptions based on the past, project them forward a few years and compute a reliable future growth rate, with a view of deriving a meaningful value for future cash flows from those figures. Then if not enough of a feat of “crystall ball” reading by itself. I am expected to conjure an estimated future PE and multiply against a figure of estimated future earnings, discount it at an appropriate rate to today’s prices, and calculate an intrinsic value per share! And then this spurious “calculated price” can be used by me (supposedly) to evaluate whether a share is worth purchasing at todays prices. If I am doing the maths flipping a coin will be quicker and probably statistically, in my case will achieve similar results.Joking aside I think it is fair to say that in my opinion the factor of estimating complex and unknown variables and projecting them in to the future, far outweighs (in terms of risk) any potential benefit over simply just using current data and the various growth ratios, past performance, or even just relying upon broker views. In terms of risk, in my opinion (obviously) I would say there is not much to choose from either method, and I personally would choose the fast approach of using current data and ratios.
Recently however I discovered something which opened a new avenue for me, a sort of half-way house between a “full-on” cash flow analysis, and merely using growth ratios.
I read about an idea of using Earnings per Share (EPS) rather than cash flow as a projection. The basic premise being that EPS already takes into account (to a lesser or greater extent) the various variables that you would otherwise have to estimate individually.
The other benefit is that it is supremely simple and fast to calculate an estimated future share price, and arrive at data that can provide a broad range of estimates based on various growth rates.
Again I wouldn’t use it in isolation, but when compared with current data and growth ratios it can provide a basis for making slightly more confident assumptions about the future.
I will cover the calcuations and provide commentary for them in a later blog post.
Author can be contacted: Investing1234@hotmail.co.uk
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