Tuesday, August 18, 2009

Fair Value Calculator

Here is a simple tool to estimate the intrinsic value of a business. I don't consider any tools like this to be adequate (intangibles matter too much) but some can be useful as a starting point.

With this one, when someone types in the stock's symbol the tool automatically plugs in this year's expected earnings (which is convenient) and then makes assumptions on earnings growth rates, discount rate, etc. The user can then make changes to those assumptions to recalculate the business value.

The tool works better for companies with predictable earnings but is less useful for cyclical companies. In the case of cyclical businesses it makes sense to enter normalized earnings instead of using this year's earnings as a baseline. Otherwise, it will significantly undervalue businesses during recessions and overvalue during economic expansions.

For example, it automatically uses earnings of $ 1.36/share for AXP but I view conservative normalized earnings for AXP to be $ 3.00/share. Using $ 1.36 and a 12% discount rate it calculates a business value of $ 30.92/share while using normalized earnings of $ 3.oo produces a business value of $ 51.80/share. (By the way...the idea that fair value can be calculated that precisely is kinda silly. Also, I don't agree with using a 12% discount rate but that's for another post.)

Again, this is only a simplistic starting point for valuing a business. The ability to judge the sustainability of a company's core economics over time matters. A tool like this is worthless if you get that wrong.

GuruFocus: Fair Value Calculator


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