To determine intrinsic value you can use one of three intrinsic value models:
Build – your – own model: Using Excel, the worksheet model is fairly easy to construct; formulas will be shown along with sample results for both indefinite continuing value and the acquisition assumption.
Prepackaged Web – based analyzer: At this writing, the data and analysis package offered by iStockResearch is the best available for free.
Intrinsic value formula as developed by Ben Graham: This simple formula is easy to apply and gives surprisingly robust results.

The one highlighted in this section is built from scratch as an Excel spreadsheet. At the time of this writing, there is little in the way of PC or Web – based models available for use by consumer investors. As noted, the exception is iStockResearch, which offers a model to non – professional investors; I offer an example later in the chapter.

Of course, any time you use a tool, its good to know in advance what outcome to expect. With intrinsic value models, you get a single – figure result: the estimated per – share value of the company. One single number: Company ABC, for example, may have a projected worth of $34.97. If youre satisfied with this number and the assumptions supporting it, you can compare this intrinsic value with current market price and make a buying decision. More likely, youll want to model a range of intrinsic values based on different assumptions. Then to complete the value appraisal, youll want to consider strategic financials and intangibles before hitting the buy button.Intrinsic Value Worksheet models
With a spreadsheet and a few initial assumptions, you can build your own intrinsic value worksheet for either continuing value assumption: the indefinite life model or the acquisition assumption model. Figure 4-1 shows an example of the indefinite life continuing value model, with formulas to help you build your own. Note that dollar figures, except per – share amounts, are in millions.

The indefinite life model
The mainstream intrinsic value model makes a mathematical assumption about so – called “continuing value.” The worksheet has nine parts.

Step 1: Growth and discount assumptions
Not surprisingly, here at the very top of the worksheet is where you can do the most damage – or the most good – to your analysis because of the potential effects of these assumptions carried over 10, 15, or 20 years, due to the power of compounding.

The most realistic way to model intrinsic value is to choose two stages; a more rapid initial growth stage and a more conservative, or flat, second stage. So two growth rates are chosen, and two corresponding discount rates are chosen. Almost always, the initial growth rate exceeds the second stage growth rate while, due to uncertainty, the second stage discount rate exceeds the initial one.
Choosing a growth assumption: To choose a growth assumption, you can rely on outside sources including professional analysts or Value Line. You can eyeball the numbers yourself and pick a number that makes sense, even with conservative bias. Or you can dig deeper and do what most professional analysts do and derive earnings growth estimates by projecting sales, profitability, productivity, and so on.
Regardless of how you decide to formulate your growth assumptions, it is important to be consistent. Comparing two businesses by using different approaches to growth and discounting assumptions can lead to trouble.

Projecting second – stage growth: To project second – stage growth, you cant use the same tools and techniques you use to project first – stage growth. Not even the most self – assured analysts try to pin down growth rates beyond ten years!

Excessive second – stage growth rates distort results because so much time is involved. And no matter what the company is, sooner or later it will exhaust market growth and penetration opportunities. Second – stage growth rates should be less than first – stage growth rates and less than 10 percent, probably no more than 5 or 6 percent. Conservative is always better.

If youre uncomfortable with second – stage growth rates and their effect on valuation, you can use the acquisition model presented later in this chapter. Although this model implies that an acquisition will take place, it can also be used to reduce sensitivity to input assumptions even if acquisition is unlikely.

Choosing a discount assumption: In theory, the discount rate should be your own personal cost of capital for this kind of investment plus equity premium thats added to the risk – free cost of capital rate. Heres the reasoning: If you can invest your money with no risk in a Treasury bond at 5 percent, your cost of capital is the risk – free 5 percent you would forego by not investing in the bond. But because Company XYZ common stock is riskier than the bond investment, an equity premium is added as compensation for assuming extra risk.

Most value investors, however, prefer a simpler approach: Just discount at a relatively high rate, usually higher than the growth rate. Conservative value investors usually use discount rates in the 10 to 15 percent range. Here are a few points to remember about discount rates:
The higher the discount rate, the lower the intrinsic value – and vice versa.
The second – stage discount rate should always be higher than the first – stage rate. Risk increases the farther out you go.
If you choose an aggressive growth rate, it makes sense also to choose a higher discount rate. Risk of failure is higher with high growth rates.
If the discount rate exceeds the growth rate, intrinsic value will be low and implode quickly the larger the gap. Aggressive growth assumptions with low discount rates yield very high intrinsic values.