![\"Intrinsic](\"https:\/\/businessecon.org\/wp-content\/uploads\/Loaf-of-Bread-Intrinsic-Value-Definition.jpg\")
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Intrinsic value’s definition has several different meanings when used in the business context. The word intrinsic refers to ‘innate’ or ‘inherent’. Whereas value refers to the exchange mindset between two or more parties. Thus, intrinsic value refers to the core understanding between parties of the worth of something. Bread is the perfect example. At its core concept, bread is a food we consume as a starch; we eat it due to its relatively inexpensive cost to fill our bellies. When you go to purchase bread at the grocer, there is already a preconceived price range for bread. Different flavors, packaging, size and type determines the final price within this predictable range. It is easy to spot prices that are too high or for some reason well below expectations.<\/span><\/p>\n Intrinsic value works the same way. When looking at the market price for a security, having knowledge of the intrinsic value prevents over paying for an investment. The key is determining this price range for the security. The primary rule for intrinsic value is straight forward; it is a RANGE and not an exact dollar value. Just as with the bakery section of the grocery store, bread is priced within a range. With value investing, the goal is to narrow this range to a set of values that are REASONABLE and OBJECTIVELY verified. Therefore, rule number two, intrinsic value must be reasonable and objectively determined. Finally, all users of intrinsic value must understand and appreciate that intrinsic value is not static. It changes every day and for highly stable companies, it should improve every day in a predictable manner with a high level of confidence.<\/span><\/p>\n The following sections cover these three rules tied to intrinsic value. The first section explains how intrinsic value is a RANGE<\/span><\/strong> of values and never a definitive amount. The second section discusses the importance of arriving at this price range in an OBJECTIVE<\/span><\/strong> manner and that the price range is REASONABLE<\/strong><\/span> given various ratios and performance indicators for the particular company. The third section below covers how intrinsic value is FLUID<\/strong><\/span> in business; it changes regularly and with highly respectable, stable operations, it is constantly improving.\u00a0<\/span><\/p>\n Determining intrinsic value is not an exact science. Intrinsic value is a range of values determined from many different variables collected, collated and exercised in several formulas to derive results. In many cases, these results are extreme with their respective outcomes. For value investors, the idea is to acquire as many different results as possible over at least five and ideally eight or more different standard formulas. From these results, a range is extrapolated. As is typical with many derived results, highs and lows are tossed due to their extreme nature. Those that remain set the boundaries of the possible outcome. The goal is finding common ground from among the remaining outcomes. Narrowing this outcome to a common acceptable monetary range determines intrinsic value.<\/span><\/p>\n An illustration is appropriate. In this case, a simple well documented company is used to determine intrinsic value – Coca-Cola<\/span><\/strong><\/a>.<\/span><\/p>\n Typically, the first step involved with determining intrinsic value is to collect pertinent data. For the purpose of brevity, the following data was collected on Coca-Cola.<\/span><\/p>\n Data Point<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a02021<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a02020<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a02019<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a02018<\/span>\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4 Year Weighted Average*<\/span><\/strong><\/span> * Weighting is as follows: 2021 – 50%; 2020 – 25%; 2019 – 15%; 2018 – 10%.<\/span><\/p>\n Over time, Coke’s market price continues to increase reflecting the constantly increasing earnings per share. This is a DOW Jones Industrial member and as such, this company is highly stable and experiences a good growth rate for such a well established company (they been publicly traded for 103 years). Excellence is their standard. As such, the market price to earnings ratio will always be strong (>20:1 ratio). In effect, it is a great company to buy when the price suddenly dips more than 25% below the most recent peak price. However, recall, market price is NOT intrinsic value. Intrinsic value reflects a fair and reasonable dollar amount that mirrors a general agreement among parties as to the worth of a security. The difference between the two prices (market and intrinsic) is the speculative risk many investors take believing the market price will continue to increase.<\/span><\/p>\n For any stock based security, a fair and reasonable value is measured utilizing a discount rate. This is the rate an owner of this particular security desires for the risk they assume. For a high quality company like this, a discount rate of 5% is very fair. Coca-Cola has very little risk but risk still exists. It isn’t government grade risk (1 – 3%); nor is at the high quality bond risk rates of 3.5% to 5%. However, it is still a super high quality stock investment risk which typically starts at around 5%. Thus, as an investor with this type of high quality stock, a five percent return on your investment is considered fair and acceptable.<\/span><\/p>\n Therefore, the very first intrinsic value formula commonly used is the dividend yield tied to the stock based discount rate. In this case, the average dividend is $1.64 and with a discount rate of 5%; the stock is worth around $33 per share. Coke is highly stable, returns a dividend to the shareholder and, at greater than 60%, has one of the strongest gross profit margins for any company. It is a super quality company to own. It would appear on the face of values that $33 per share for intrinsic value is low. Thus, more intrinsic value formulas are required.<\/span><\/p>\n Intrinsic value formulas are commonly grouped by financial data. Historically, a very well respected formula advocated by Benjamin Graham and David Dodd (the Fathers of Value Investing) is a formula tied to earnings. Their popular formula is:<\/span><\/p>\n Value = Earnings times ((8.5 plus (2 times a reasonable growth rate))<\/span><\/p>\n With Coke, this would equal:<\/span><\/p>\n Earnings of $2.06\/Share times ((8.5 + (2X3.7));<\/span> Take note how close this is to the dividend discounted result from above. However, a value investor should never rely on just two results. More are required.<\/span><\/p>\n A third and quite common approach is to use the discounted earnings formula. This formula is a income statement based formula and assumes earnings are normal and not inclusive of unusual or infrequent events. However, Coke, just like every other company, did experience an unusual event starting in March of 2020. COVID affected all companies across the board. With Coke, it definitely caused a decrease in sales in the amount of $4.3 Billion; thus, net profit was most likely reduced around $1.2B which in turn reduced earnings per share that year approximately 28 cents per share. In the overall scheme of things, this probably impacted the average earnings per share about 6 cents (due to the weighting effect of the 4 year average). The question here is this, should a value investor use the historical recorded average of $2.06 per share or adjust this for the COVID situation?<\/span><\/p>\n Surprisingly, the answer is to NOT adjust the average. The key is the average. Since 2019’s value is only weighted 25%, the net impact is slightly higher than 6 cents in the overall result. This aggregated 3% difference (6 cents divided by $2.06) isn’t going to dramatically affect the end result (with business, dramatic refers to a change of more than 5%)<\/span> with the discounted earnings formula, or for that matter any long-term time derived result (discounted formulas customarily utilize 20 plus years to derive a result). Discounted future values are grounded in the near future over the extended future. The first seven years typically are worth more than 30% of the end result.<\/span><\/p>\n In this case, using a discounted earnings tool, Coke’s intrinsic value is estimated at $36.03 over the next 30 years assuming a discount rate of 7.75% and a growth rate of 3.7%.\u00a0<\/span><\/p>\n A Side Note<\/strong><\/span> Notice how this result is slightly higher than than the first two results? Often, value investors adjust the variables in the formula around the earnings. The two variables are the growth rate and the discount rate. Let’s assume a more conservative approach and increase the discount rate to 8.25% and reduce the growth rate to 2.9%; again, the idea is to be more conservative with the outcome. Using these factors, the intrinsic value shrinks to $30.96 per share.\u00a0<\/span><\/p>\n A more aggressive approach might be to reduce the discount rate to 7.25% and leave the growth rate as is, 3.7% (it is very difficult for companies that are fully mature, in this case Coke has been in business for over 130 years, to have strong growth rates greater than 4% per year). Using this more liberal approach, the discounted earnings approach values the shares at around $38.25.\u00a0<\/span><\/p>\n A user of this formula could extend the number of years with discounting future earnings and go to 40 years; this will add anywhere from $3 to $5 per share depending on whether the value investor incorporates conservative or liberal values for the two variables.<\/span><\/p>\n Notice already, the RANGE that is beginning to develop. To this point, the following results exist:<\/span><\/p>\n This pattern results in a RANGE of a low $31 per share (conservative approach, 30 years) to a high of $45 per share (liberal approach, 40 years). There are still more intrinsic value formulas an investor could use. Many investors like to resort to cash flow as a more reliable indicator than earnings. In general, there are two sets of cash flow values to use. The first is purely the operating cash flow. This is basically earnings adjusted for non-cash expenditures such as depreciation and amortization. Coke has a very strong amortization deduction each year related to the years of growth when they purchased many rights to own certain brands, formulas, distribution venues etc. over the last 40 years.\u00a0<\/span><\/p>\n From the schedule above, operating cash flows exceed earnings by approximately $2.3 Billion per year, or around 53 cents per year per share. In effect, the discounted formula uses $2.59 per share as the substitution value over $2.06 of earnings average per year. This additional 53 cents per year, increases the overall intrinsic value result about $9 per share. With the more conservative approach, the additional 53 cents per year increases the result around $8 per share.\u00a0<\/span><\/p>\n The key question here is, which is better? Should a value investor use discounted earnings or should an investor use discounted operating cash flows? The answer is is highly dependent on the investor’s belief system related to how cash flow is utilized. Most investors believe that it is important for the cash to be used to reward shareholders with dividends, reduce the overall risk of the company (paying down debt) and investing cash for future growth or to maintain the current growth rate.\u00a0<\/span><\/p>\n Think about this for a moment, if Coke doesn’t take their cash and invest some of this money as capital expenditures, the growth rate of Coke will drop over the next 10 years and it is possible, that without this reinvestment into new products, geographical expansion and developing expanded distribution systems, the company could begin to retrench as the competition will take advantage of this non-growth position. Since, most of the values derived above are heavily reliant on a moderate to strong growth rate, a good portion of the operating cash must be used to maintain the company’s market share and overall position in this industry. In effect, Coke must reinvest some of this $2.4 Billion per year to maintain their overall position. Reviewing the cash flows statement identifies that Coke reinvests around $1.5 Billion per year.\u00a0<\/span><\/p>\n The end result is that most of the 53 cents per share from cash flow is reinvested to maintain the company’s overall market position. Thus, a value investor can use operating cash flow as the basis in the discounted formula<\/span><\/strong><\/a>; but, the investor must adjust this for the required investment to maintain the company’s overall market position. This is known as ‘Free Cash Flow’ (Operating Cash Flow less Capital Reinvestment).\u00a0<\/span><\/p>\n With Coke, once you adjust the cash flow for maintenance requirements, it effectively ends up just slightly more than purely earnings, around $2.24 per share as the basis for discounted formula. This adds about $3 more per share with the end results and not $9 per share utilizing nothing but operating cash flow. Now the results are as follows:<\/span><\/p>\n Again, the overall range of values expands slightly to a high of $48 per share. The range is now a low of $31 to a high of $48. Statistical analysis states to toss the extremes of $31 and $48 and now the range becomes a low of $33\/share, Dividend Yield, to as much as $45\/share, Discounted Earnings Liberal Approach.\u00a0<\/span><\/p>\n Most of the results are from $36\/share to $41\/share. A RANGE<\/span><\/strong> of values is now set. The next step is to narrow this RANGE to something REASONABLE and OBJECTIVE.<\/span><\/p>\n A Side Note<\/strong><\/span> Is an intrinsic value of $36 to $41 reasonable and objective? How can you tell? Well, there are several tools available to value investors to confirm or independently verify that this is a good range of values. The most commonly used tool is the price to earnings ratio. <\/span><\/p>\n If you look at the history of Coke, the price to earnings ratio, i.e. the market price against the earnings hovers in the 20’s. The market price to earnings rarely dips below 20:1. This chart illustrates Coke’s PE ratio over the last five years. The sudden high PE ration in 2018 is a direct reflection of Coca-Cola taking advantage of the new tax law in December 2017 and paying a dramatic amount in taxes reducing their overall net earnings. Since the average market investor is aware of this, they are not going to suddenly reduce the market price for Coke. Thus, if the market price remains stable and the earnings drops dramatically, the ratio inversely changes. In effect, 2018 is an anomaly. By the way, this is one of the flaws of the PE ratio and is explained in detail in the lesson about price to earnings<\/span><\/a><\/strong> in the Business Ratios<\/span><\/strong><\/a> section of Value Investing on this website.<\/span><\/p>\n From above, the market is willing to spend at least 20 times earnings to own this stock. Current earnings plus some excess cash flow totals around $2.24 per share. At a PE of 20, that makes Coke’s market value approximately $45 per share. Value investors don’t want to buy stock at commonly accepted market prices, it just means that you will only earn dividends and although the yield will be good, value investors desire strong overall returns. To achieve this, the buy price, which is set below intrinsic value, must be dramatically (> 5%) less than intrinsic value. With Coke, given the unusual quality this company provides to its shareholders, a price differential including the additional 5% for margin of safety must exceed 25% in order to justify the risk associated with the holding period. An illustration is warranted here.<\/span><\/p>\n Assume that a fair market price is $45 per share based on a minimum 20:1 PE ratio. Given the risk of time to recover to a fair market price, a 25% discount is required to buy the stock. 25% of $45 is $11.25. Thus, to buy this stock, the value investor sets the buy point at $33.75 per share. This buy point is at least 5% less than intrinsic value. This makes intrinsic value approximately $35 to $36 per share. Take note how this is at the low end of the range established in the prior section.\u00a0<\/span><\/p>\n Thus, using PE ratios as a barometer of value, discounting the minimum average PE ratio 25% from the most recent look back period of five years can provide some insight to intrinsic value. If the minimum PE ratio increases to 25:1, the fair market price increases to $56 per share. A 25% discount puts the buy point at $42 per share. If this is at least 5% below intrinsic value, then intrinsic value is estimated at $44 per share. Notice how this estimate is well above the expected intrinsic value range of $36 to $41. However, it is within the overall range calculated in the prior section (Discounted Earnings Liberal Approach Price).<\/span><\/p>\n A Side Note<\/strong><\/span> Using a 25% discount of a minimum expected market PE ratio is just one tool to provide additional confidence of the resultant values from the various intrinsic value formulas used when determining an intrinsic value range. Think of it as a quick objective outcome.\u00a0<\/span><\/p>\n Another objective tool is to ‘Appraise’ the company. Naturally, appraising Coca-Cola would take several years. Thus, to conduct a quick appraisal, one must use reasonable expectations related to determining fair market value of Coke’s assets. A quick look at Coke’s assets identifies the following on 12\/31\/21:<\/span><\/p>\n Current Assets\u00a0 \u00a0 \u00a0 \u00a0$22.5B<\/span> Most of the intangibles are Trademarks and Goodwill. Basically, Coke purchased these rights over the last 70 years to gain market share for non-alcohol beverages. Fixed assets reflect manufacturing, distribution and office facilities. Investments are mostly equity positions in other beverage companies, geographical territories and distribution venues. Since assets are recorded at cost under Generally Accepted Accounting Principles, their step-up in value to fair market value is not done and not reported on the balance sheet.<\/span><\/p>\n The step-up to fair market value is very effective with fixed asset intensive businesses like real estate, utilities, shipyards etc. Coca-Cola’s balance sheet relies intensively on intangibles. There is a very involved process to appraise intangibles. Thus, using this appraisal tool isn’t going to work with evaluating Coke’s overall asset position at fair market value less its liabilities to determine net aggregated value which is one way of measuring intrinsic value. A good illustration of how market appraisal effecitively calculates intrinsic value is with a REIT, please read Intrinsic Value of Essex Property Trust<\/span><\/strong><\/a> to learn more.<\/span><\/p>\nIntrinsic Value – A Range of Monetary Outcomes<\/strong><\/span><\/h2>\n
\nRevenue\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $38.6B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$33.0B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$37.3B\u00a0 \u00a0 \u00a0 $31.9B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$36.3B<\/span>
\nGross Profit\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $23.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$19.6B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $22.6B\u00a0 \u00a0 \u00a0 $20.1B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$21.9B<\/span>
\nGP Margin\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 60.3%\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a059.4%\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a060.6%\u00a0 \u00a0 \u00a0 \u00a063.0%\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a060.4%<\/span>
\nNet Profit\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$9.8B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $7.8B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $8.9B\u00a0 \u00a0 \u00a0 \u00a0 $6.4B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $8.8B<\/span>
\n# of Shares Trading\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a04.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 4.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a04.3B<\/span>
\nEarnings\/Share\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$2.28\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.81\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $2.09\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.51\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$2.06<\/span>
\nDividends\/Share\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.67\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.64\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $1.59\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.56\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$1.64<\/span>
\nBook Value\/Share\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $5.31\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$4.48\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$4.43\u00a0 \u00a0 \u00a0 \u00a0 \u00a0$3.98\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$4.84<\/span>
\nOperating Cash Flow\u00a0 \u00a0 \u00a0$12.6B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $9.8B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $10.5B\u00a0 \u00a0 \u00a0 \u00a0 $7.6B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$11.1B<\/span>
\nFree Cash Flow\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $11.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $8.7B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $8.4B\u00a0 \u00a0 \u00a0 \u00a0 $6.3B\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$9.7B<\/span>
\nGrowth Rate\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a03.7%<\/span>
\nDiscount Rate\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 7.75%<\/span>
\nAverage Market Price\u00a0 \u00a0 \u00a0 \u00a0 $56\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $55\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$52\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $47<\/span>
\nDividend Yield\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 2.98%\u00a0 \u00a0 \u00a0 \u00a0 \u00a02.98%\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a03.05%\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 3.32%<\/span>
\nPrice to Earnings Ratio\u00a0 \u00a0 \u00a024.5\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a030.4\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a024.9\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a031.1<\/span><\/p>\n
\n$2.06 X (8.5 + 7.4);<\/span>
\n$2.06 X 15.9;<\/span>
\n$32.75\/Share<\/span><\/p>\n
\nThe discount rate used with the discounted earnings formula here is different than the discount rate used in the dividend yield formula. In the dividend yield formula, the discount rate reflects a much improved overall risk position because it is dividends and not earnings. Dividends are a direct payment to the shareholder; whereas earnings doesn’t guarantee all of it going in the shareholder’s pocket as dividends. Thus, the discount rate for earnings includes not only the portion tied to equity ownership (the 5% desired rate used with the dividend yield formula), but also the ‘no risk’ desired discount (usually around 2%), the size premium and the specific risk (is there a market for Coke’s securities). Thus, the discount rate for the discounted earnings and cash flow formulas is always higher than the discount rate for dividend yield.<\/span><\/p>\n\n
\n
\nThe more stable the company, the more reliable the discounted formula becomes. Mid-Cap companies require additional supplemental formulas to assess intrinsic value in addition to the discounted method. Use fair market valuations for fixed assets; incorporate business ratios; and utilize the company’s notes to the financials to identify critical key performance indicators. As the company moves through its life span and improves, the discount rate also improves (decreases). For Mid-Caps, discount rates of 11% and higher are necessary to account for the additional risks associated with these companies. For those that are improving within the Mid-Cap level of companies, the discount rate tends towards 11% from 12%; for those companies unable to improve or demonstrate sound financial results year after year, the discount rate must increase to compensate for this additional risk. Value Investors SHOULD NEVER<\/strong> consider Small-Caps, Penny stocks or even Over-The-Counter investments. For those types of companies, additional tools are required to determine intrinsic value and the associated risk of deriving a reliable result is magnified dramatically. This is why value investors should only consider the top 2,000 companies and within this pool of potential investments, only those that demonstrate continuous growth and performance during recessions or unusual events.<\/span><\/p>\nIntrinsic Value – A Reasonable and Objective Outcome<\/strong><\/span><\/h2>\n
Price to Earnings<\/strong><\/span><\/span><\/h3>\n
![\"Intrinsic](\"https:\/\/businessecon.org\/wp-content\/uploads\/Coca-Colas-PE-Ratio-Five-Years.jpg\")
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\nPlease take notice of something interesting here, the discount explained above is different than the discount used with the Discounted Earnings\/Cash Flow method in the prior section. Some readers will ask, why is it that this discount in this section is almost four times greater than the discount used in the prior section (discounted earnings\/cash flow). There is an outright difference between the two uses of the term ‘discount’. In the prior section, discount is tied to multiple risk factors AND extrapolated over an extended perid of time. Whereas, in this section, the discount is instantaneous and is driven by a limited set of factors that can impact its value. In this case, the value investor’s risk is a very short period of time (six or less months) and the value investor needs to have dramatic change in a very short period of time. In the prior section, the different variables of growth and earnings are addressed over a very long time frame, 30 or more years. The end result is this, as time decreases, the discount rate must adjust accordingly, i.e. increase.<\/span><\/p>\nMarket Appraisal<\/span><\/strong><\/span><\/span><\/h3>\n
\nInvestments\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$18.4B<\/span>
\nFixed Assets\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $9.9B<\/span>
\nIntangibles\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$41.3B<\/span><\/p>\n
![\"Intrinsic](\"https:\/\/businessecon.org\/wp-content\/uploads\/Coca-Colas-Price-to-Book-12-Years.jpg\")
During the recession time period of 2008 through 2011, the price to book was low. Then it slowly rises to today’s 11 to 1 ratio.\u00a0<\/span><\/p>\n