How to find the true value of a stock

[Leoinv]

What is an unbiased way to find the true value of a stock after it has seen a recent flight of capital and what is a true value vs price measurement?

[Bill M]

John Cochrane recently ran a MOOC on this subject, http://coursera.org/course/assetpricing. His stochastic calculus formula, P=E(mx), depends on (1) your personal utility function, (2) your personal discount rate, etc. So everyone's "true value" is different. But the best indication of "true value" is what someone else will pay for it; like the most recent market quote.

[k66]

...But the best indication of "true value" is what someone else will pay for it; like the most recent market quote.

Exactly. And when you have as many people as possible offering these opinions, the better. Valuation by consensus.

[knpstr]

What is an unbiased way to find the true value of a stock after it has seen a recent flight of capital and what is a true value vs price measurement?

As Warren Buffet says "That's the trick".

If you can answer that question accurately, you can become a very very rich person. I don't know myself how to best answer the question. It is different for different companies on how you find it (metrics are different in different industries). It is basically the price you would pay for the business if you were buying the whole business and taking it over to run it yourself. In doing this you'd analyze the prospects of the business try to get a feel for how much profit it would return to you, then offer a price so that profit gives you a return acceptable to you on that price paid.

However, it is NOT what other people pay for it. Value does not equal price.

[kolea]

This begs the question of what is "true value". This is partly a semantics questions, partly a finance question.

From a finance standpoint, the SEC requires companies to report financial information, and from that a book value can be derived. Book value can be considered "true value" since it is the total value of all assets, minus liabilities, of the company. Some companies have lots of intellectual property (like MSFT) and that gets hard to assign a dollar value to.

However from a market perspective, "true value" will be whatever the market sets the price at.

But there is a third possibility, what I think of as the true value of an asset (although hidden), which may be what you are trying to get at. Clearly some assets are thought to be undervalued by the market (i.e., Value stocks), and this valuation is not book value, and it is not market value. I don't think there is a standard way to calculate this hidden "true value". Buffet has his method, and indexes that create lists of value companies, have their own methods. Finding a reliable formula for this "true value" would be a very valuable thing. The ratio of price-to-book-value is usually prominent in finding undervalued assets.

[JoMoney]

One method to determine the "value" of a stock would be to come up with a price you'd be willing to pay for the entire company, then just divide it out by the number of shares outstanding, as a group the shares represent complete ownership of the business.

http://www.berkshirehathaway.com/letters/1992.html
... In The Theory of Investment Value, written over 50 years ago, John Burr Williams set forth the equation for value, which we condense here: The value of any stock, bond or business today is determined by the cash inflows and outflows - discounted at an appropriate interest rate - that can be expected to occur during the remaining life of the asset. Note that the formula is the same for stocks as for bonds. Even so, there is an important, and difficult to deal with, difference between the two: A bond has a coupon and maturity date that define future cash flows; but in the case of equities, the investment analyst must himself estimate the future "coupons." Furthermore, the quality of management affects the bond coupon only rarely - chiefly when management is so inept or dishonest that payment of interest is suspended. In contrast, the ability of management can dramatically affect the equity "coupons."

The investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase - irrespective of whether the business grows or doesn't, displays volatility or smoothness in its earnings, or carries a high price or low in relation to its current earnings and book value. Moreover, though the value equation has usually shown equities to be cheaper than bonds, that result is not inevitable: When bonds are calculated to be the more attractive investment, they should be bought.
...
Though the mathematical calculations required to evaluate equities are not difficult, an analyst - even one who is experienced and intelligent - can easily go wrong in estimating future "coupons." ...

[moshe]

One method which has validity to my mind. Of course this may have nothing to do with actual share price today.

Track the next 5 years of projected cash flows plus the terminal value 5 years out and then figure the present value using the firms current weighted average cost of capital.

Divide the result by the shares outstanding to come up with a reasonable price per share.

Then, compare to the current PPS and current book value per share and try and explain the differences.

Or just buy VTI (or VT) and sleep well at night.

~Moshe

[JoMoney]

...Or just buy VTI (or VT) and sleep well at night...

http://www.berkshirehathaway.com/letters/2013ltr.pdf
Most investors, of course, have not made the study of business prospects a priority in their lives. If wise, they will conclude that they do not know enough about specific businesses to predict their future earning power.
I have good news for these non-professionals: The typical investor doesn’t need this skill. In aggregate, American business has done wonderfully over time and will continue to do so (though, most assuredly, in unpredictable fits and starts). In the 20th Century, the Dow Jones Industrials index advanced from 66 to 11,497, paying a rising stream of dividends to boot. The 21st Century will witness further gains, almost certain to be substantial. The goal of the non-professional should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well. A low-cost S&P 500 index fund will achieve this goal...

If you adopt a strategy of averaging in over time you'll find that you sometimes you were buying "high" and other times buying "low", but your average price will be "average". It's a great strategy to strip out the speculative price changes in the market and get closer to achieving a fair share of the value created by the businesses you own rather than trying to create something extra by buying a selling them in the market as if that did anything to create value.

...If “investors” frenetically bought and sold farmland to each other, neither the yields nor prices of their crops would be increased. The only consequence of such behavior would be decreases in the overall earnings realized by the farm-owning population because of the substantial costs it would incur as it sought advice and switched properties.
Nevertheless, both individuals and institutions will constantly be urged to be active by those who profit from giving advice or effecting transactions. The resulting frictional costs can be huge and, for investors in aggregate, devoid of benefit. So ignore the chatter, keep your costs minimal, and invest in stocks as you would in a farm.

[TravelerMSY]

I've found Aswath Damoradans books and online resources to be helpful. Start with "The Little Book of Valuation."

[ourbrooks]

Why do you want to know? There is no principle, rule or, even, empirical observation that the market price of a stock has to converge on or be anywhere near the asset value.

[Caduceus]

A stock is a fractional interest in a real company, so to find the true value of a stock, you have to be able to value the business itself. You will reach a reasonable range rather than a precise figure.

It's not an easy skill, or all the money managers would be very rich. You could learn some accounting and reading of financial statements if you are interested, but investing in index funds is much better.

[rkhusky]

No investment has intrinsic value. The value is always what someone else is willing to pay for it, whether it is gold, land, houses, paintings, antiques, stocks or bonds.

[knpstr]

No investment has intrinsic value. The value is always what someone else is willing to pay for it, whether it is gold, land, houses, paintings, antiques, stocks or bonds.

This is wrong.

[Professor Emeritus]

A stock is a fractional interest in a real company, so to find the true value of a stock, you have to be able to value the business itself. You will reach a reasonable range rather than a precise figure.

It's not an easy skill, or all the money managers would be very rich. You could learn some accounting and reading of financial statements if you are interested, but investing in index funds is much better.

Plus not all shares are "worth" the same.

[packer16]

Damodaran's "Little Book" is probably one of the best introductory books. He has more detailed books if you are interested in more details of valuation techniques. Also check out his web site and blog as his site has alot of data used in valuation models and his blog has alot of nice recent examples of valuation. In answer to your question, it depends upon the company's life cycle and state of operations which valuation technique you would use. Also there is no true value but a range of reasonable value associated with each company.

Packer

[Maynard F. Speer]

Value is the price the market's willing to pay for it .. just with the proviso that the market can take a while to work out what it's willing to pay for it ..

e.g. Valuing Biotech companies is extremely difficult (because most the value's in intellectual property), but investors are piling in right now, and whether these companies prove to be worth the 10x book value people are paying for them is something the market's going to find out .. (it reminds me of the dot.com bubble, when people didn't understand what they're investing in)

I think nowadays we appreciate just how much specialist knowledge it takes to properly value companies, and why meeting management in person is important ... However a simple metric I find useful is the PEG ratio: price/earnings divided by forecast growth .. Or PEGD p/e divided by growth + dividend .. Ideally looking for values below 1

[MP173]

Is it possible to determine the true value of a stock until you have experienced the complete cycle of purchasing, holding and selling?

Just about everything else is pure speculation, isnt it?

For example, back in 2011 I was watching JNJ (Johnson and Johnson) closely and decided if it dropped into the 50s I would buy. Finally on 9/22/2011 I decided at $62.23 it was time to buy, regardless of my discipline. It worked out well and today my investment in JNJ has risen by 78%. What a great value it was.

Or was it? The same investment in SPY would have had a 94% return over the same period of time.

Which was the better value? The better investment?

Too early to tell. I am satisfied with my investment at this time. Since I already own the SPY, this was a concentrated movement into JNJ. I ended up with a company with a AAA bond rating and a 2.8% yield...almost bondlike.

Check with me in 10 years on the JNJ value. I should have a better idea then.

Also on my SPY value.

Ed

[rnitz]

An interesting attempt to answer this question was written on the blog Philosophical Economics: http://www.philosophicaleconomics.com/2 ... ecides-it/

His basic position is that the "intrinsic" or "true" value of a stock is what you'd be willing to pay for it if you could never sell it. The only value is what could be extracted in dividends (and growth of dividends). Completely divorces the issue from a current market price (greater fool theory?) I'm in the camp that the "true" value is what someone else will pay for it, but I found the article and the line of thought very interesting.

P.S. If you haven't discovered this guy's blog, it's a real treat. Must be a finance professor somewhere who is (anonymously) entertaining himself, and many of us as well.