Many people try to locate and then buy value stocks. While that is a solid principle and one that generally leads to success, the question is, “How do I find and judge a stock?” Well, there are several ways to achieve this, with some being more popular than others. But using a stock’s intrinsic value is Warren Buffett’s preferred method. With that in mind, let us examine this Method and some others that may be helpful to you in this quest.
The first is from a free spreadsheet found on a website that several free Google Sheet spreadsheets and some for a price. I have used both and can recommend them if used as a basis for your evaluation of a particular stock. In the example, I will use the AT&T symbol, T. This particular stock closed Friday, March 19, 2021, at $29.76 and is held widely due to the lucrative dividend that the stock pays quarterly. Again, on Friday, that dividend was $2.08 annually for a 6.93% return. But what do the numbers say about T and its potential? That is where the type of valuation you elect to use and the key inputs to the projection. Now, let me straightforwardly state this, no matter what method you decide to use, They are projections and no one, and I mean no one, can predict a stock’s future value no matter what method is utilized.
If you go to Value Spreadsheets, you will find a series of useful free spreadsheets and some that are available for a cost. I have purchased the spreadsheet with three additional intrinsic value calculators, and I find it worth the price, though it is not inexpensive. But the free sheet will calculate an intrinsic value based on the Discounted Cash Flow model. In this spreadsheet, you can select what you would like the margin of safety to be. The higher the margin, the lower the suggested purchase price will be. This spreadsheet also allows you to select what you would like the growth decline rate, discount rate, and the length of the FCF that will be used. In the spreadsheet, it defaults to 5% for both the rates and 12 for the FCF valuation. If you use a 25% margin of safety, the DCF intrinsic value is $16, and at 50%, it is $14. Using this approach, the stock is overvalued and would not be considered a buy.
If you elect to purchase the Value Spreadsheet, you will get three extremely useful methods to assist you in making a selection. In these examples, we will use the same criteria as was used in the free DCF model. The value spreadsheet’s three methods that carry a price are the P/E Valuation, a Discounted Cash Flow method, and ROE Valuation. When used with the free spreadsheet, it will provide you with four methods to help you in your decision. The spreadsheet also provides you a good rating of the company by assigning it a score between 0 and 100. The higher the score, the better the company may be. In the case of T, it scored a 19, meaning that the company has some issues. A tab goes into detail about what each component means and how it relates to the company’s score. In the paid version, you may also input your desired return rate, which we have set at 20%.
Then there are the three different valuations. We will look at these three with a 25% margin of safety only for simplicity’s sake. Using the P/E Valuation, we get $13 pr three dollars off the free FCF Method. This further confirms that T’s price is seemingly overvalued. Then there is the ROE Method that returns a price of $18, which is slightly higher than the FCF Method but still in the general area of the other two methods. And finally, the Discounted Cash Flow Method is an outlier with a price of ($4), meaning T’s value is negative.
But you must study the company before you can select your criteria for these models, and yes, they can make a big difference. I use Y-Charts and Morningstar as part of my analysis process. Using the Y-Charts Method and criteria, T is undervalued as they have a price projection of $30.33. On Morningstar, they have a fair market value of $36 with a buy point of $21.60, closer to the intrinsic values we obtained. So, as you can now see, what we use as imputes for our intrinsic models is key to obtaining accurate estimates.
This means that you cannot simply rely on the spreadsheets’ defaults but rather need to develop what you believe are solid figures based on your research of the company. If you think that a 5% discount rate is high for the current rate environment, you can use one of 2%. While the P/E Method is now $15 and the DCF Method is now positive at $4, the ROE Method is $37, meaning that based on the current value of $29.76, it would be considered overvalued by two methods and undervalued by the third with the average intrinsic value being $19.16.
While not perfect, it provides a baseline that you can use to gauge your interest in a company. Remember not always to select the default settings and do your homework to arrive at these all-important inputs.
Try the free spreadsheet and see how it works and play around with your inputs to see how you can see the entry price under different conditions. As with any instrument used to project a stock’s price understand the model and all its inputs and components.
If you need assistance with any questions, please contact me directly or another Registered Financial Consultant.
