Tо be consistent with the value investing approach, you must understand what a company is worth before you make an investment decision. If only it were so simple. Valuation has been the subject of vast theoretical study and debate – as well as experience and learning – in the investing community. Business valuation is at best an inexact science that no two people do exactly the same way. The goal of this chapter is to expose you to some of the techniques and underlying principles. Whether you apply them rigorously to every investment decision or just keep them in the back of your mind is up to you.
A How – to Valuation Guide
The following value investing model is one that you can use as is or modify to meet your own needs. Its designed for non – professionals, those with just a few hours a month to review and select investments.1. Screen companies.
Using P/E, P/S, or other chosen ratios, get a list of companies to evaluate. The list can include industries considered timely by popular investment analysts, companies you read about in the financial press, or companies you deal with in everyday life that appear to have their act together. In addition, online stock screeners are useful for this step.
2. Calculate intrinsic value.
Using formulas presented in the next section, estimate intrinsic value for each chosen candidate.
3. Assess each companys strategic value.
Develop a checklist for key business performance measures. Then, add a checklist and evaluate intangibles. For details, check out the upcoming sections “Looking at Strategic Financials: Its All about ROE” on strategic financials and “Evaluating Intangibles” on strategic intangibles.
4. Decide whether the price is right.
Compare current price to intrinsic value, sprinkle in strategic value assessments, and bake in a dash of judgment. The later section “Deciding When the Price Is Right” walks you through this process.
