Determining the Intrinsic Value of a Stock

Price is what you pay and value is what you get. 

For example, you pay SGD2.60 for a cup of McDonald's coffee black and SGD1.10 for an equivalent kopi 'O' from a HDB coffeeshop.  Who's to say one cup of coffee is overpriced or underpriced as the value to the drinker differs from one to another?

When it comes to stock investment, the 'flavour' is removed from the equation and you can determine the inherent or intrinsic value of a share in a relatively objective way by using Value Investing.

Here is an overview from Wikipedia:-

"Value investing is an investment paradigm which generally involves buying securities that appear underpriced by some form of fundamental analysis, though it has taken many forms since its inception. It derives from the ideas on investment that Benjamin Graham and David Dodd began teaching at Columbia Business School in 1928 and subsequently developed in their 1934 text Security Analysis. As examples, such securities may be stock in public companies that trade at discounts to book value or tangible book value, have high dividend yields, have low price-to-earning multiples or have low price-to-book ratios.

High-profile proponents of value investing, including Berkshire Hathaway chairman Warren Buffett, have argued that the essence of value investing is buying stocks at less than their intrinsic value. The discount of the market price to the intrinsic value is what Benjamin Graham called the "margin of safety". The intrinsic value is the discounted value of all future distributions.[citation needed] However, the future distributions and the appropriate discount rate can only be assumptions. Graham never recommended using future numbers, only past ones). For the last 25 years, Warren Buffett has taken the value investing concept even further with a focus on "finding an outstanding company at a sensible price" rather than generic companies at a bargain price.

Graham never used the phrase, "value investing" — the term was coined later to help describe his ideas and has resulted in significant misinterpretation of his principles, the foremost being that Graham simply recommended cheap stocks."

As for calculation of intrinsic value, the following YouTube clip provides a good discourse.

Click here for Lesson 21. Warren Buffett Intrinsic Value Calculation - Rule 4 

Invest With Eyes Wide Open

Unlike gambling on a soccer match (think Russia 2018 and make that soccer matches) or a horse-race, you have more leeway to make a sound investment by learning how to pick a profitable stock.

Photo by Roberto Nickson (@g) on Unsplash

To understand the elephant-anatomy of a share, you can invest with eyes opened wide by using a four-step formula which The Fifth Person has called The Investment Quadrant comprising the following four components:

1. Business Quadrant

2. Management Quadrant

3. Financials Quadrant

4. Valuation Quadrant

You will need to look at the Business of your target company (e.g. relative competitiveness, flair with automation/innovation and quality of products) and the industry in which it operates (e.g. sunset industry, environmental impact and future growth prospect). 

The company is only as good as its Management team, particularly, its top management which could determine whether it succeed or fail spectacularly. Horror of horrors even in this time and age, notwithstanding public scrutiny and security-industry watchdogs, there are CEOs and Executive Directors who commit unimaginable (that's how creative they are) white-collar crimes or blatantly neglect their duties and responsibilities.

While the Financials of a company are rudimentary factors for seasoned investor to consider, the rookies would pass by them and go with their gut feelings.

Then, there is Valuation which offers a more clinical research of the intrinsic value of a company through Book Value approach, Equity and Debt approach, Discounted Cash Flow approach, Relative Valuation approach and Option Valuation approach.

Click here for The Investment Quadrant: The 4-step formula to picking the best stock investments.

The Dividend Aristocrats

"The One Strategy That Beats Wall Street" written by James Altucher is one of the best article I have read on shares investment in a long while.

It is solid common sense to win over impatient investors who are raring to make a killing in the stock markets at a fast and furious pace by pouncing on what's hot and throwing caution to the wind.

When it comes to shares investment, what is 'boring' with consistency may well give you a better return on your bucks. So, buckle up on a less Ferrari-like vehicle and look through a windscreen for companies that pay dividends unfailingly.

Photo by Caleb Woods on Unsplash

As Altucher let on, "Dividends are the simplest way to collect a piece of a company’s cash flow. When a company pays a dividend, it shows they’re serious about sharing profits with investors. Every other smart investor I’ve met says the same thing."

Click here for The One Strategy That Beats Wall Street and meet the so-called Dividend Aristocrats.

To digress, you may be torn between buying a blue-chip share which costs a lot more per unit as opposed to, say, a Real Estate Investment Trust (REIT).

In Singapore context, a bank like DBS Group Holdings Ltd may pay an annual dividend of, say, SGD 1.20. Based on its recent closing price of SGD 28.30, the return on an investment of 1,000 shares costing SGD 28,300.00 would be SGD 1,200.00 (4.24%).

On the other hand, a REIT like Ascott Residence Trust may distribute SGD 0.08 per units per annum and 1,000 units costing SGD 1,110.00 (based on its recent closing price of SGD 1.11) would yield an income of SGD 80.00 (7.20%).

Other things being equal, it would seem that you would be better off with Ascott in the above scenario. 

But, of course, in reality, there is a host of these other factors which could affect the outcome of your investment choice. For example, DBS may have a bigger upside or downside in price movement and Ascott's future performance is subject to a myriad of factors such as competition (or dominance, on the flip-side) and interest rates on its borrowings.

For sure, companies that pay good dividends annually are alive and kicking. The dividends they pay you is like a bird in the hand which is worth two in the bush of non-paying ones. Be sure to include some of these 'aristocrats' in your investment portfolio after doing your usual due diligence of the target companies you have in mind.