Estimation of Stock’s Fair Value Price Range

monthly-dividend-portfolio-reviewIn my stock analysis process, I attempt to estimate the fair value of a given stock. I estimate the fair value range (instead of a one fair value). This estimation should be interpreted as the price I am willing to pay based on my risk profile and my investing objective. My fair value estimation does not necessarily attempt to determine the fair value based on value investing principles.


My process of determining the fair value captures the essence of “what is being priced by the market” and “historically what has been priced by the market”.

(I) NPV price based on 15 year DCF: I have discussed DCF based net present value pricing.

(II)  Average high yield price calculated based on past 10 years

I am attempting to estimate what would be current stock’s price based on its historical dividend payment standards. I measure this using yield. It is calculated as follows.

(i) For Year 1, I calculate the high yield in percentage.

[(Year 1 dividends) / (lowest stock price in Year 1)]


(ii) I continue to calculate this for Year 2, Year 3, and so on. Ideally, I would like to calculate this for at least past 10 years, but in many cases data is not easily available. I calculate for as many number of years as possible, and then make judgment call if it is worth digging more data.


(iii) I calculate average of ‘high yield’

[Year 1 high yield + Year 2 high yield + …..] / (number of years)]

This gives me 10 year average high yield.


(iv) I calculate the price based on this 10 year average high yield.

[(Current Dividends) / (10 year average high yield)]


(III) Pricing relative to 10 year average PE ratio

Here, I am attempting to estimate what would be current stock’s price based it’s historically market pricing.

(i) For Year 1, I calculate the average PE ratio.

[(Year 1 average stock price) / (adjusted EPS)]


(ii) I continue to calculate this for Year 2, Year 3, and so on. Ideally, I would like to calculate this for at least past 10 years, but in many cases data is not easily available. I calculate for as many number of years as possible, and then make judgment call if it is worth digging more data.


(iii) I calculate 10 year average PE ratio

[(Year 1 average PE + Year 2 average PE + …..) / (number of years)]


(iv) I calculate the relative price based on this 10 year average PE ratio.

[(Trailing Three Years Average EPS) x (10 year average PE ratio)]


(IV) Pricing based on PE ratio of 12

This is very simple straight forward calculation.

[(Trailing Three Years Average EPS) x (PE ratio of 12)]


(V) Graham number

Graham number is the formula Ben Graham used to calculate the “maximum” price one should pay for the stock. According this rule of thumb – the product of P/E ratio and price-to-book should not be more than 22.5 (P/E ratio of 15 x price-to-book value of 1.5). The 15 P/E came from the thought that Graham wanted his portfolio to have a yield that is equal yield to that of AA bond (during those days this yield being 7.5%). The inverse of this yield is 1 divided by 7.5%. This is approximately equal to 13.3, which Graham rounded up to 15. I calculate Graham number as follows:

Square Root [ (22.5) x (book value per share) x (EPS) ]

I have been investigating to use tangible book value in this formula. I may change this in future. But for now, I will continue to use book value. I have observed that it does not have any significant effect on my fair value range calculation.


Fair Value Range

At this point, I go on to calculate the fair value range.

High End = [ Average of above five criteria ]

Low End = [ (Average of above five criteria) – (0.5)x(Std Dev) ]

I hope this helps understand how I estimate fair value for my stock investments.

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23 Responses to “Estimation of Stock’s Fair Value Price Range”

  1. Mahesh says:

    Incredible Explanation. :).

    Very less people are interested in educating novice investors about stock market.

    keep up the hard work.

  2. TIP Guy says:

    Mahesh,
    Thanks for stopping by and glad to know your visit was worthwhile.

    Hope to see you more often.

    Best Wishes,

  3. Supal Patel says:

    Great analysis. Can you please help me with following related questions:

    1) As all above analysis is data driven, what source(web site) you recommend to get all the data required for this analysis?

    2) Any idea why book values at different site (MoneyControl , rediff , BSE) are different? What is the authentic source for book value data?

    • TIP Guy says:

      Hello Supal,

      (1) I use moneycontrol to start the data collection (and then use 50% verification at rediff and 50% verification at company annual reports. I also add new information as necessary).

      (2) Honestly, I do not know why the difference. I can speculate it – may be due to different ways they calculate book values. Book values can be tangible book value or intangible book value depending upon how you calculate.

      (3) Book value is not the “only” parameter I use for my fair value calculation. In my calculations, it is one parameter along with four other parameters. Therefore, it is not very very significant for me. It is important to be consistent in using same approach rather than trying to be precise. I take it from company balance sheet (if not available then use money control value).

      Thanks for stopping by!

      Best Wishes,

  4. Arun says:

    Hi,
    Excellent – keep it up!

    I was curious about one thing: InWhen this analysis is rigorously applied to the universe of stocks, have you/do you miss out on potential multi-bagger? Sorry to be asking a Lynch-ish question to a Buffeter 😉

    Rgds,
    Arun

    • TIP Guy says:

      Arun,

      If you haven’t already noticed, I like to go for consistency and sustainability. I tend to go for lower expected growths. This way I know the probability of success is much higher.

      Looking for that elusive multi-bagger has less probability. And may be I am not skilled at it.

      Plus, if you look at my portfolio, aren’t they multi-bagger? In my book, all on them are multi-bagger. Honestly, I just don’t know what multi-bagger really means.

      Best Wishes,

  5. Naveen says:

    Hi,

    Can you please let me know which site should I use to get previous 5/10 yrs data about the companies to import the data in excel file. Also if ay site provides forward PE, forward EPS values??

    Regds
    Naveen

    • TIP Guy says:

      Hello Naveen,

      I use moneycontrol. And then I verify randomly from rediff and annual reports. I spend about 30min to 45mins for verification. But it is one time only so worth it.

      I don’t know where to get forward looking PE or EPS values. I do not use readily available values for these parameters. In my DCF calculation, I use my own projections for both.

      Hope this helps.

      Best Wishes,

  6. Neil says:

    Graham’s number is/was used only to arrive at a fair price for utility company stocks. It more or less disqualifies ‘growth’ stocks.

    • TIP Guy says:

      Hello Neil,

      Interesting! How do you define growth? Isn’t growth relative to something? and isn’t perception of growth subjective (for that matter even value?).

      BTW – I do not think Graham’s number is only for utility stock! If you focus on fundamentals (and not examples), then may be that will help change your perspective.

      Good question! Thanks for stopping by and leaving a message.

      Best Wishes,

  7. Neeraj Goyal says:

    Hi Tip guy,

    Moneycontrol.com publishes only standalone financial numbers. But now a days most companies operate through subsidiaries thus, consol. financial numbers are actually relevant. How to overcome this problem? because generally in most cases only last 5 or max.6 years’ Annual reports are available on company website (in some cases that too not available).

    In US, everything is available on SEC website. Do we not have any such site or source in india?

    Thanks in advance

    Regards,
    Neeraj

  8. TIP Guy says:

    Hello Neeraj,

    Keep things simple. You want to buy a holding company, look at financial of a holding company (or ticker that is listed). And, in general, you will have financials of the holding company.

    You want to buy a subsidiary, look financial of the ticker that is listed.

    example, bajaj holdings vs. bajaj auto.

    if a holding company is not listed, how can you invest, even if you want to look at financials.

    So how is your question relevant? can you please elaborate. Are you saying, the listed company is “holding company” and financial under its ticker is for subsidiary?

    Best Wishes,

  9. Neeraj Goyal says:

    Hi Tip Guy,

    I think u did not get my question. Let me explain u through an example. Take example of TATA Communications (formerly VSNL). Company has done a big acquisition in 2005 of Teleglobe through its unlisted 100% subsidiary TC International. Right now this unlisted subsidiary contributes nearly 70% of TATA Comm. Group’s turnover. If you see moneycontrol.com it will show numbers of standalone financials of TCL. which will not depict the correct picture. For correct picture you need to see Consolidated financials of TCL group which are not available in moneycontrol.com but available in annual report. same is the case in most companies like say TATA steel, their standalone numbers are showing profit because corus numbers are not included in that. but when u see consolidated numbers of TATA steel, u get to know that they are making huge losses.

    Turst this clarifies my concern for taking numbers from moneycontrol.com

    Regards,
    Neeraj

    • TIP Guy says:

      Hello Neeraj,

      OK, I think I got it now. I haven’t looked at most recent TATA Communications or TATA Steel. However, it depends upon the entity you are looking at and how it is structured.

      In case of Tata Steel, I think it is driven by how media projects, without trying to understand the entity itself.

      There is a higher entity called Tata Steel Group (TSG). Under TSG, there are multiple entities such as Tata Steel Ltd (BSE – 500470), Tata Steel UK/Europe (a.k.a Corus), Tata Steel Thailand, Natsteel, etc.

      Tata Steel Ltd is a standalone entity. It is incorporated and listed as a standalone entity (but is considered part of TSG). This represents all of India Operations. Therefore, it has a standalone financials. This particular entity, BSE code 500470, does not include TSG’s other international operations. Annual report shows both Tata Steel Ltd and TSGs consolidated results. In fact, I read somewhere (forgot where) that Tata Steel Ltd has applied to keep international subsidiaries out of this company.

      Now, I do not know if TSG is independently traded in India or how this entity is structured. All Global Operations are domiciled in Singapore. It includes international operations such as Corus, Thailand, Natsteel, etc. This one does not include Indian Operations.

      Therefore, when you look at Tata Steel Ltd, you only see standalone financials. That’s how it should be, because we would be investing in this entity and not other global operations. The way Tata Steel Ltd. deals with other such subsidiary are like an external customers.

      I am sure that’s how other entities are also structured.

      Best Wishes,

  10. Imran says:

    I think the level of transparency in the US for data availability is unparalleled and India lags far far behind. I have been for scouting for such a source that provides 10 yrs but only to find disappointment in the end. Some companies have smartly exploited situation and developed their business model on supply of such data. These companies charge as high as 1.25 lakh per annum for subscription to such database.

    We can’t expect Indian to catch with US anytime soon. In case anyone finds such a source of data (even if cheaply available), please let me know at naqviimran@gmail.com. Thanks.

    • TIP Guy says:

      Hello Imran,

      You have a good question. But I can’t address it here.

      We could crib about transparency in US or lack of data in India. But that’s not going to help. You need to understand reasons behind it. Our markets/business environment lack ethics. It lacks respect for originality. Is lacks respect for somebody else’s work. Our IP laws and coypright laws are not strong and they are not executed. In US, you are screwed if you voilate IP laws or copyright laws. Can we say the same here? I think you get the answer!!

      If data is provided free, someone nut job will modify it and sell it in open market. And nothing will happen to them. For example, last year, when my blog was new, I got sample stock analysis report as an offer to subscription in my real email. It was 70% same analysis as what I publish on this blog for free.

      Best way is; take them as one additional constraint in working in Indian Economic Environment. Find a way, and move on.

      Good Luck!

  11. Imran says:

    Hi Tip Guy,
    It would be very helpful if you could upload one of the live analysis spreadsheet on the site, so that we could actually get the hand of the actual process you follow while arriving at the stock’s real value. Thanks.

    • TIP Guy says:

      Hello Imran,

      I think I have presented and discussed here as much detail as possible about my process and analysis.

      Following is what many readers (I know of at least 18) have done:

      They have done the hard work to dig the data and read annual reports. They have tried to simulate my analytical process. They have shared their excel sheets and their analysis with me to find error or modifications or direction. AND I have happily commented or critic’d them.

      I hope you get the message.

      Good Luck!

  12. Just wanted ya to know I like your website.

  13. Aby says:

    TIP Guy

    From where are you getting the lowest and highest price of the stock for each year?? also how are you finding average price of the stock in any given year

    I can see that you have taken average of last three EPS for majority of calculation like price based on PE 12, price based on historic average PE , price based on Grahams number . Are you using average EPS or Latest EPS for your DCF analysis.. I guess it is the latest EPS you are using for extrapolating into future.. . Any specific reason for that ? .. I know its not going to make any major difference.. but still would like to know..
    thanks

  14. Shan says:

    Hello TIP Guy,
    You website is amazing good information for novice investors like me. It would have been great help (for the debutant like me) if the Fair Value Price Range calculations is explained with an example.
    (Could you share some examples?)

    • TIP Guy says:

      Hello Shan,

      All analysis on this blog have calculation of fair values. I have presented the fundamentals and explained the process. So to learn, try one yourself, instead of looking for exact recipe, use process to come up with one for your own. Any questions feel free to ask.

      Lot of my readers have been able to do that.

      Good Luck and Best Wishes,

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