Intrinsic Value

Being an engineer I've always felt comfortable only after I see the numbers inside a formula. I've always wished to find such a magical formula to help me evaluate my stock interests. After scouring the internet and investment books for such a formula I finally found one while reading my Warren Buffet Biography "The Snowball". It was created by Benjamin Graham, who Warren Buffet studied under during his Columbia MBA days. The formula is simply called the Benjamin Graham formula and it calculates the intrinsic value of a stock based on current AAA Corporate Bond yield and a stock's Earnings Per Share (EPS).

The Graham formula proposes to calculate a company’s intrinsic value V* as:



V*: Intrinsic Value
EPS: the company’s last 12-month earnings per share
8.5: the constant represents the appropriate P-E ratio for a no-growth company as proposed by Graham
g: the company’s long-term (five years) earnings growth estimate
4.4: the average yield of high-grade corporate bonds in 1962, when this model was introduced
Y: the current yield on AAA corporate bonds

I currently use this formula on all my investments as it helps me evaulate a stock's potential. Other key numbers I look for are Cash vs Market Cap and Cash vs Debt. Warren Buffet as well as Jim Cramer are huge advocates of undervalued stocks that possess equal Cash to Market Cap values. I also like to incorporate Cash to Debt because any company with a huge debt tells me that their management is either being too ambitious or being sloppy with the accounting books.