FFB-Post 25
In the world of investing, finding the true value of a stock, especially a growth stock, is crucial. Benjamin Graham, the father of value investing, developed a formula that helps us estimate the intrinsic value of a growth stock—one that accounts for the company’s potential future growth. This formula isn’t widely known but is incredibly useful for identifying undervalued stocks with growth potential.
The Growth Formula:
V = EPS x (8.5 + 2G)
- V = Intrinsic Value
- EPS = Latest Earnings Per Share
- 8.5 = The PE ratio assigned to a stock with a 0% growth rate
- G = Expected Growth Rate for the next 10 years
Breaking it Down:
- Intrinsic Value (V): This is what you calculate using the formula. It’s the value you believe the stock is actually worth based on its earnings and growth potential.
- Earnings Per Share (EPS): This is a company’s profit divided by the number of outstanding shares. It represents the portion of a company’s profit allocated to each share.
- Growth Rate (G): This is the expected annual growth rate of the company over the next 10 years. To get a reliable estimate, we often use the average growth rate from the past 10 years.
Example:
Let’s say we’re evaluating a company called Tech Innovators Inc. Its latest EPS is ₹50, and its average growth rate over the past 10 years is 6%.
Applying the formula:
V = 50 x (8.5 + 2 x 6)
V = 50 x (8.5 + 12)
V = 50 x 20.5
V = ₹1025
So, the intrinsic value of Tech Innovators Inc. is ₹1025 per share.
Margin of Safety:
Graham always emphasized the importance of having a margin of safety to protect against unforeseen risks. To calculate this, multiply the intrinsic value by 0.7 (or 70%) to get your safe entry price:
Entry Price = 1025 x 0.7 = ₹717.50
This means that for Tech Innovators Inc., a safe buying price would be ₹717.50 or lower.
Why Use the Growth Formula?
The beauty of this formula is that it factors in growth potential, something that a standard PE ratio doesn’t do. By incorporating expected growth, you’re not just looking at where the company is today, but where it could be in the future.
Next Up: Portfolio Management
In the next post, we’ll dive into portfolio management—how to balance your investments, manage risk, and ensure long-term growth.
Stay tuned!
For Post 26 – Click Here -> Portfolio Management