The important investment question is how you can estimate true value.

"In the final analysis the stock market is not a voting mechanism but a weighing mechanism."
Benjamin Graham, Security Analysis

Valuation metrics have not changed.

• Eventually, every stock can only be worth the present value of the cash flow it is able to earn for the benefit of investors.  
• In the final analysis, true value will win out.  
• The important investment question is how you can estimate true value.

Markets can be highly efficient even if they make errors.

• Stock valuations depend upon estimations of the earning power of companies many years into the future. Such forecasts are invariably incorrect. 
• Moreover, investment risk is never clearly perceived, so the appropriate rate at which the future should be discounted is never certain. 

Thus, market prices must always be wrong to some extent.

• But at any particular time, it is not obvious to anyone whether they hold only "undervalued" stocks and avoid "overvalued" ones.  
• The fact that the best and the brightest on Wall Street cannot consistently distinguish correct valuations from incorrect ones shows how hard it is to beat the market. 

Buffett's Opinion on Calculation of Intrinsic Value

Try using Free cash flow.
Set a process for identifying future cash flows and based on that try to calculate intrinsic value of a company.

Read what is written by Warren Buffett in his letters to shareholders. 

While writing about Calculation of Intrinsic value in the Owners manual Buffet says...

Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.

The calculation of intrinsic value, though, is not so simple. As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover — and this would apply even to Charlie and me — will almost inevitably come up with at least slightly different intrinsic value figures. That is one reason we never give you our estimates of intrinsic value. What our annual reports do supply, though, are the facts that we ourselves use to calculate this value.

Read owners manual on http://www.berkshirehathaway.com/

Intrinsic Stock Value

When it comes to investing, everyone wants to know what stocks are going to go up. Unless you have the ability to see into the future, you'll have to settle for doing things the old fashioned way: by research them. Even though it may not be possible to be right on all of your stock picks, you can tilt the odds in your favor by learning as much as you can about the stocks you're investing in. One useful tool that you can use to make an educated decision on whether or not to buy a stock is the intrinsic value, which gives you an idea of approximately what the stock is worth.

Valuing a stock is not always very easy to do. Ratios like the P/E ratio give you a quick idea but it doesn't go into depth very well. The intrinsic value makes up for some of what the P/E ratio lacks by accounting for its growth rate and the discount rate. The growth rate allows the intrinsic value (IV) to value the stock not only on their currentearnings per share but also on their future earnings per share. The term "discount rate" refers to the rate that you would have to earn to make an investment worth the risk. By accounting for this, it helps weed out some stocks that may be less lucrative investments.

Calculating the Intrinsic Value

There are actually a few different ways to calculate the IV but we'll just go over the most common method. To get started, you must first gather the company's EPS figures. You then take this number and divide it by the annual return of the investment you are comparing it with (discount rate). For example, if XYZ stock has $3.46 in earnings per share and you want to compare it with 6% treasury bonds, you simply divide 3.46 by .06 to get an intrinsic value of 57.66. This means that XYZ stock has an intrinsic value of 57.66. So this means that, relative to government bonds, the stock is "worth" about $58 per share.

That example only takes into consideration the stock's current earnings. If you are interested in finding out what the stock will theoretically be worth next year, you just substitute next years expected EPS with the current one. So if XYZ stock is expected to earn $3.90 per share next year, you divide 3.90 by .06 which gives you an intrinsic value of $65, relative to government bonds.

Calculating the intrinsic value seems pretty complicated and if you don't like doing all of the math, you can cheat by using Quicken.com's evaluator to have it figure the IV for you.

Using the Intrinsic Value

I know all of this sounds pretty confusing but, trust me, it really isn't. Calculating the intrinsic value is probably the most confusing part. Using it is actually pretty easy. Now that you know what the stock is "worth", you can compare its current stock price with its intrinsic value to decide if it is worth the risk. For example, if XYZ was trading at $45, you would consider it undervalued because its trading at a price that is less than its IV of $58. However, if it was trading at $75 per share, it would be considered overvalued.

The only big disadvantage that the intrinsic value has is that it doesn't allow you to calculate it for stocks that don't have positive earnings. So if you were hoping to figure out the value of that hot new internet stock, you might want to use another method. But, in general, the intrinsic value has very nice advantages over other methods and I've even found it more accurate. By using it, you give yourself one more way to check out a stock to decide if it really is worth the risk.

http://www.teenanalyst.com/stocks/intrinsic.html

Calculation of Intrinsic Value

I have created an excel sheet that could be usefull when calculating Intrinsic values of stocks.
All you have to do is open the excel sheet, and fill in the red numbers in the excel sheet, which you can find on the links next to each box.
Excel will then automatically calculate the intrinsic value of the stock you are analyzing.

If you want to change the ticker, open a hyperlink in a box next to a red number, and change the ticker in the web address.
For example, if you are looking at http://finance.yahoo.com/q/ks?s=PEP+Key+Statistics and you would like to see the data of Coca Cola co. instead of Pepsico, change the ticker from PEP (which is the ticker of Pepsico) to KO (which is the ticker of Coca Cola).
The link to visit then becomes: http://finance.yahoo.com/q/ks?s=KO+Key+Statistics for example.

Method number one is a very simplistic model, which calculates a price target for the next 5 years based on historical valuations, the last 4 quarters results and future growth.
Method number 2 is more advanced, and takes into account Free cash flow, net cash position and future growth.
This method discounts the future values at a discount rate of 9% per year, which is the return you can expect over the long run in the stock market (7% price appreciation per year + 2% dividend yield per year).

To open the excel sheet, please click here: Calculate_Intrinsic_Value

Please be aware that calculating an intrinsic value is not an exact science. It is based on subjective estimates.
The best thing you can do is to use methods used by the biggest value investors in the world, such as Warren buffet, Joel Greenblatt, Monish Pabrai and the likes…

http://profitimes.com/value-investing/calculation-of-intrinsic-value/

How to Calculate Intrinsic Value for Stock Investing

How to Calculate Intrinsic Value

Discounted Earnings, Instead of Just Cash Flow

Summarized Overview

You will find information about why you should calculate intrinsic value in stock market investing, and step by step guide on how to do it.

You will also find information about which key financial ratios to use and what you have to do after calculating intrinsic value.

Why You should Calculate Intrinsic Value

Simply because, you don't buy any stock at any price, do you? Do you know why? Because you want as much return as possible!

The price you are paying is the ultimate determinant for the rate of return that you'll be earning. The higher the price you pay for it, you'll be getting lower rate of return. This is why, you need to know how much a stock worth. Once you know its value, you can identify which stocks are traded at discounted price.

However, buying a stock simply because it is cheap is not the right approach either. This is another reason to calculate intrinsic value. To buy quality stocks at discounted price, value for money right?

How to Calculate Intrinsic Value

The way to go is, search for stocks whose prospects you believe in ( with good stock pick method ) and then use a valuation technique to ensure the purchase price is acceptable. Here, I use net present value (NPV) formula.

How to do it? Let say you are valuing stock ABC,

From 13 years historical data, you get the information as above. To proceed, you also need to firm up your expectation based on your risk profile. In this example:

• I set my investment horizon as long as ten years from 2007. So that in 2018 I can use the fund to finance my children's study
• I am confident stock ABC will continue growing 13 per cent per year for the next ten years (13 years records prove this stock able to grow 13 per cent EPS per year)
• I assume stock ABC will be having the same PER and dividend payout by end of 2017 (or early in 2018)

I am expecting 12 per cent return on investment (ROI) so that my initial investment able to cover my children's tuition costs in ten years time.

Let's start calculating intrinsic value of stock ABC.

Step One: Forecast Share Price

First of all, you need to forecast its share price ten years down the road. In this case, I project the price for the next ten years using 13 per cent per year growth.

Step Two: Forecast Total Future Value

Secondly, you need to calculate the total future value. This must include the potential dividend as well.

Look, some investors doesn't care much about dividend. To them, dividend is just too small to be considered. But as it has effect to the total future value, it should be taken into consideration.

By the end of the day, you can compare the stock's profitability to others; which may not pay any dividend at all.

Step Three: Calculate Intrinsic Value

After having all these data, then only you can calculate the intrinsic value for stock ABC.

Step Four: Compare with Current Stock Price

The intrinsic value above is because my goal is to get 12 per cent per annum from this stock. If so, current stock's price, which is $33.50, is acceptable indeed (stock price is below the intrinsic value).

How Do You Calculate Intrinsic Value? Discounted Cashflow Discounted Dividend Discounted Earnings Never Calculate What For?

But if your goal is about getting 25 per cent per annum return on investment, the intrinsic value will be $22. In this case, the current stock price will no longer acceptable for you.

For this same reason, you can say that current stock price is suit to those who are aiming for 15 per cent return per annum (in economics, this called as Internal Rate of Return or IRR)

What's Next?

As you can see, intrinsic value can be relatively different from one investor to another depending on the expected return. Expecting very high return will limit your investment options. On the other hand, having very low expected return may as well better keep the cash in fixed deposit.

As an investor, it is crucial to set a realistic target on the expected profits.

It is better if before you calculate intrinsic value of your selected stock, assess your own risk profile first. This will help you to determine your realistic preferred return based on your need, ability and investing habits.  Eager to buy stock? Hang on first! You need to have the fair value as another comparison. This is what mention by Warren Buffet's guru, the margin of safety 

http://www.stock-investment-made-easy.com/calculate-intrinsic-value.html

Calculating Intrinsic Value

Security Analysis 401: Calculating Intrinsic Value

By Sham Gad 
August 23, 2007 |

In the previous three articles in this "Security Analysis" series, I discussed the concept ofmargin of safety, explained why you should rely on intrinsic value to make investing decisions, and showed why you want to find great businesses with wide economic moats. Once you've taken those steps and found a business that looks attractive, you next need to determine theintrinsic value of that business, to find out whether a bargain of an investment opportunityexists.

Every business has an intrinsic value. According to John Burr Williams in his 1938 publicationThe Theory of Investment Value, that value 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 business.

This definition is painfully simple, but it works. Let's apply it to a couple of businesses so you can see for yourself.

Solid, stable cementCEMEX (NYSE: CX  ) is a Mexican producer and distributor of cement. Competing with the likes of LaFarge (NYSE: LR  ) , it is one of the largest cement players in the world. It produced free cash flow -- cash from operations less capital expenditures -- of about $2.6 billion in 2005 and around $2.75 billion in 2006. Meanwhile, between 2004 and 2005, it grew free cash flow by around 50%, but that same figure was virtually flat from 2005 to 2006. That may give you an inkling that it makes no sense to try predicting a different rate of cash flowgrowth each year. Instead, when attempting to calculate intrinsic value, you should stick to one or two consistent conservative growth rates, although smaller companies starting with a lower base figure can be assigned higher rates of growth. When calculating intrinsic value, I use a 10-year forecast, because I think that's an adequate time period to provide sufficient data, and I apply a 10% rate discount rate, which is equivalent to the S&P 500's historical return.

Cemex, however, is a huge business, and while it may experience some years in whichcash flows grow abnormally, it's more logical when determining its intrinsic value to use a meaningful conservative figure. Always work with a margin of safety.

In this case, it's reasonable to assume that Cemex can grow its free cash flow by 10% for four years. While this growth rate can continue for a longer period, I like to be extra cautious and predict that free cash flows stabilize at a 3% growth rate thereafter. Cemex is a very well-run company, and there will always be a need for cement in the world, so I think 3% free cash flow growth is very achievable.

Let's look at the calculations. Dollar figures are in billions.

Year	Free Cash Flow	Present Value of FCF
2007	$3.02	$2.75
2008	$3.30	$2.75
2009	$3.70	$2.75
2010	$4.02	$2.75
2011	$4.43	$2.75
2012	$4.56	$2.57
2013	$4.70	$2.41
2014	$4.83	$2.25
2015	$4.98	$2.11
2016	$5.13	$1.97

The sum of the present value (PV) of the free cash flows comes to about $25 billion.

Next, you need to determine a terminal value for the business. Conservatively, I assume that Cemex would be worth 10 times its 2016 free cash flow, or $51.3 billion, which has apresent value of $19.7 billion. So by adding all of the PV cash flows together, my estimate of intrinsic value for Cemex comes to about $45 billion. With about 790 million shares currently outstanding, Cemex has a per-share intrinsic value, based on my assumptions, of approximately $57 a share, versus the current stock price of $31.

Does this mean you should back up truck and load up on Cemex? No, even though I do think Cemex is a fantastic company selling at an attractive price. For one, the number ofshares outstanding 10 years from now will surely be a different number from what it stands at today. Assume, for example, that the share count rises to 1 billion shares and the intrinsic value comes down to $45 a share. Then you're talking about a whole different set of numbers.

Most importantly, though, you need to know the business inside and out in order to estimate cash flow growth with a high degree of confidence. The ability to assess the quality and competence of management thus becomes critical. Knowing how management spends company dollars tells you a lot about how much cash the company will produce years down the road. In short, do your due diligence ... and when you are done, do it again.

The hard part

Calculating intrinsic value is simple and straightforward. It's having accurate data that's the difficult part. That's why Benjamin Graham remarked: "You are neither right or wrong because the crowd disagrees with you. You are right because your data and reasoning are right." That's also why Warren Buffett, the best investor on the planet, spends a lot of time focusing on businesses with durable competitive advantages, such as the brand value that Coca-Cola(NYSE: KO  ) offers, or the monopoly-like industry that American Express (NYSE: AXP  ) operates in.

It's easy to predict future cash flows with a high degree of certainty for businesses like this -- ones that have wide economic moats insulating them from the threat of competition. That gets back to our last discussion. And it shows how all of our discussions tie together to make you a better investor.

http://www.fool.com/investing/value/2007/08/23/security-analysis-401-calculating-intrinsic-value.aspx