Intrinsic value of a stock

A share is a claim on a company's future cash. Intrinsic value tries to put one number on that claim today. When people set it against the share price, they are asking whether the market pays more or less than the business seems to be worth.

The idea goes back to Benjamin Graham and David Dodd, whose 1934 book Security Analysis drew a line between a company's price and its value.

The most common method is a discounted cash flow (DCF) estimate. Money that arrives later is worth less than money today, so each year's expected free cash flow is shrunk by a discount rate and the results are added up.

Here r is the discount rate, the return an investor asks for to wait and to carry the risk, and g is a long-run growth rate that has to stay below r. The terminal value stands in for every year after the forecast.

Other methods exist. The dividend discount model values only the dividends. The Graham number and similar rules of thumb combine earnings and book value. Many analysts simply compare multiples such as P/E or EV/EBITDA with similar companies.

Take a business expected to produce $100 million of free cash flow next year, growing 3% a year for good. At a 9% discount rate it is worth about $1.67 billion: $100 million divided by 0.09 minus 0.03.

At 8% the same business is worth $2.0 billion. At 10% it is worth about $1.43 billion. One percentage point in one assumption moves the answer by 14% to 20%, before anyone has argued about the cash flows themselves.

• Cash flows are forecasts. Nobody knows a company's sales, margins and investment needs ten years out.
• The discount rate is a choice. It reflects how much risk the analyst sees, and small changes move the result a lot, as the example shows.
• The terminal value is often more than half of the total. Much of the answer rests on what happens after the forecast years.
• Some businesses do not fit. Young companies that still burn cash, and banks and insurers, whose cash flows are part of their balance sheet, are hard to value this way.

Graham's answer to this uncertainty was the margin of safety: a gap between a conservative estimate of value and the price, wide enough to absorb mistakes in the estimate. The idea admits that the estimate will be wrong and asks only that it be wrong by less than the gap.

• PlainTicker does not compute a fair value or a target share price. A single number would look more precise than any forecast can be.
• It shows the inputs a valuation rests on, from the company's SEC filings: free cash flow, margins, returns such as ROIC, debt, liquidity and growth.
• It compares valuation multiples (P/E, EV/EBITDA, P/B and free cash flow yield) with the company's sector peers, so you can see how the market prices it next to similar companies.
• It shows the F-Score, a check of what changed between the last two annual reports.
• The reader draws the conclusion.