Most so called experts that calculate intrinsic value utilize either the discounted earnings or the discounted cash flow to determine intrinsic value. They solely rely or emphasize only this discounted formula to determine intrinsic value. This is a highly flawed approach. In order to do this, the formulas take future earnings or cash flow out 30 years and then discount them back into today’s dollars. This may work well for bonds as the payments are written and known as facts. Predicting earnings in 20 years along with inflation and growth of the respective company is not only risky but just downright an exercise in frustration. Benjamin Graham, the father of value investor, placed greater emphasis on predicting the future in the near term, i.e. seven years out. His formula is to simply predict the future near term growth and have knowledge of current earnings and one can determine value. From above, Graham’s formula is:<\/span><\/p>\n

V= Earnings (8.5 + 2g)<\/span><\/p>\n

Using $5 as the average earnings per share and 7% as the growth rate, The Walt Disney Company is worth $112.50 per share. With modern day value investing, a discount rate is applied to future earnings rate over a period of 20 to 30 years depending on how conservative the value investor’s approach. The more conservative, the lower the number of years. For readers, please be aware, the DISCOUNT rate and the GROWTH rate are different. The discount rate is explained in detail above. For The Walt Disney Company, the discount rate is 9.7%. In addition to this discounted earnings, a terminal value is also set and this final value is also discounted back to today’s dollars. The reason a terminal value is applied is because earnings is net of depreciation\/amortization which most companies reinvest this value back into their existing assets in order to maintain their physical\/market value. Thus, a terminal value is added to reflect the sale or continued use of these assets beyond the time period exercised.<\/span><\/p>\n

For the purposes of Disney, it is determined that in the first year earnings will be $5 per share and this is discounted back to today at 9.7%. This means that in Year 1, the $5 received will be worth $4.55. In Year 2, the $5 of earnings will grow 6% (see above where it was determined that growth for Disney is 7% but for the purposes of determining value, 6% is used in years 2 through 6 and then 5% growth in all following years. Thus, Year 2’s earnings are $5.30 and when discounted back two years to today, it is worth $4.41 in today’s dollars.<\/span><\/p>\n

This pattern continues for four more years through Year 6. Total discounted value after Year 6 is $25.14. Now, growth slows to 5%. Remember, predicting growth is difficult and actually impossible to be accurate. Thus, it is always best to be conservative and reduce the growth rate the further one goes out from the current time period. This is a good conservative approach and adds to creditability of the end result. Thus, for the purpose of this formula, Disney’s growth is 5% for years seven through twenty. These next fourteen years add an additional $39.27 for a cumulative value of $64.41 for twenty years of earnings. Review the following table:<\/span><\/p>\n

YEAR 1 ($5 of Earnings, Discounted at 9.7%)\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$4.55<\/span>
\nYEARS 2-6 ($5 of Earnings Growing at 6%\/YR, Discounted at 9.7%)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $20.59<\/span><\/span>
\nAccumulated Value After Six Years\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$25.14<\/span>
\nYEARS 7-20 ($6.68 Earned in Year 7 Growing at 5%\/YR, Discounted at 9.7%)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$39.24<\/span><\/span>
\nAccumulated Value After Twenty Years\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$64.41<\/span><\/p>\n

It is difficult to believe that Disney is only worth $64.41 after twenty years of earnings. However, the formula isn’t complete yet. There is still one more part remaining. With discounted earnings, the formula requires some form of terminal value after Year 20 and this value is discounted back to today’s dollars to add to the total value of the earnings during this 20 year period. Why is this done? Well, think of the going concern principle. Disney is NOT in business to stop conducting business 20 years from now. This company will continue to grow and continue as a profit generating corporation per the demand of the shareholders. Thus, 20 years from now, there will still be assets out there and these assets have value. The question is this, what is going to be the value of those assets 20 years from now?<\/span><\/p>\n

Before approaching this step, many of you are wondering, why in this case, didn’t the formula go out further in time? Two reasons, first, one more year of earnings in YEAR 21 is $13.89 (includes the 5% growth in Year 21). This $13.89 discounted back 21 years at 9.7% per year adds $1.99 to the total value. If the formula designer did this for Years 21 through 30, it adds a mere $16.45 making the total value for earnings $80.86 over the course of 30 years. Thus, the law of diminishing returns is kicking in and each subsequent year isn’t really adding enough value to justify continued reliance of forecasted growth and the thought of the discount rate staying stable at 9.7%.<\/span><\/p>\n

The key is the terminal value. Here, the formula designer will utilize a very large value and discount this back to today’s dollars. This value will overshadow the continuation of the value associated with earnings during Years 21 through 30 and beyond discounted back to today’s dollars.\u00a0<\/span><\/p>\n

Thus, what is the best terminal value to use? The answer highly depends on the designer of the formula and their core belief system for business. One model of belief is that the net profit reflects the application of depreciation\/amortization towards the continued maintenance of the existing balance sheet assets. To illustrate, in 2022, The Walt Disney Company’s combined depreciation and amortization was $5.16 Billion. Customary maintenance of existing assets is about 3% of the asset’s value per year. Therefore, total fixed and intangible assets at the end of 2021 was $170 Billion. To maintain $170 Billion from one year to the next at 3% is equal to $5.1 Billion. Thus, Disney’s depreciation\/amortization is maintaining the existing assets of this organization. And this further reinforced by the value from the ‘Investing’ section of the cash flows statement whereby Disney paid out $5 Billion to maintain their parks, resorts and all other property. Therefore, the net earnings of $5 in Year 1 ends up as cash in the bank or some form of current assets. After 20 years, the balance sheet will simply mirror the current balance sheet assuming the respective earnings are used to pay dividends and eliminate all the debt. In effect, after 20 years, what will remain are the NET ASSETS or what is commonly referred to as equity. This means, Disney’s terminal value will match the current Disney Shareholder’s Equity position of $95 Billion or $51.35 per share. Simply insert this with Year 20’s earnings to get a final value. Since it would take a year to cash out the assets, most formula designers just insert this value as earnings in YEAR 21.\u00a0<\/span><\/p>\n

If inserted in Year 21, this $51.35 is worth $7.35 in today’s dollars. Thus, the total intrinsic value utilizing the Discounted Earnings Method (Book Value as Terminal Value) is as follows:<\/span><\/p>\n

YEAR 1 ($5 of Earnings, Discounted at 9.7%)\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$4.55<\/span>
\nYEARS 2-6 ($5 of Earnings Growing at 6%\/YR, Discounted at 9.7%)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 $20.59<\/span><\/span>
\nAccumulated Value After Six Years\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$25.14<\/span>
\nYEARS 7-20 ($6.68 Earned in Year 7 Growing at 5%\/YR, Discounted at 9.7%)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$39.24<\/span><\/span>
\nAccumulated Value After Twenty Years\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$64.41<\/span>
\nTerminal Value Utilizing Book Value Per Share in Year 21\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$7.35<\/span><\/span>
\nTotal Intrinsic Value (Discounted Method\/Book Value as Terminal Value)\u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0 \u00a0$71.76<\/span><\/p>\n

There are still other more sophisticated thinking. One stipulates that Disney would eliminate all debt as it earned its profits and this in turn would reduce future interest costs which improves net profits further. In addition, the existing assets would continue to grow or at least mirror inflation over this twenty year period. This is similar to Cost Value Inflation Adjusted from the balance sheet section above. Thus, instead of $51.35 per share as terminal value, $161 per share would be the terminal value ($89 per share currently at 3% inflation rate for 20 years) which adds $23.04 making the total intrinsic value $87.45 per share.<\/span><\/p>\n

Others will argue that the Cost Value FMV Adjusted amount of $108 per share and a 3% inflation for twenty years is the proper terminal value. Under this concept, the $108 per share is worth $195 in Year 21 and at a 9.7% discount rate makes the terminal value worth $28 per share. Thus, the total intrinic value is now $92.32 using the Discounted Earnings Method (FMV Terminal Valuation).\u00a0<\/span><\/p>\n

Here’s a summary of the results for income statement based intrinsic value formulas:<\/span><\/p>\n