Estimating a share’s intrinsic value 101

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Estimating a share’s intrinsic value 101

In my previous article on thinking rationally about shares, I outlined the case for buying quality companies at a discount to intrinsic value. But what is that? The basic formula for estimating intrinsic value, using an approach called excess returns, is simple arithmetic. It compares the return generated by the business’s equity to the return that an investor should reasonably expect from a share market investment and uses the result to determine what premium to pay for the equity. The formula is:

(Return on Equity / Required Return) X Equity = Intrinsic Value Estimate

To obtain intrinsic value per share, divide the result by the number of shares on issue.

While the division and multiplication are simple, producing a straight line model with its own set of limitations and determining the inputs requires some thought. It’s a case of garbage in, garbage out. When Berkshire’s Charlie Munger was asked what made him such a successful investor, he responded by offering “My guesses are better than yours.”

Applying the formula..continues on link

 

http://arxiv.org/pdf/1308.0958.pdf

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