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Author: jwedgwood One star, 50 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 18386  
Subject: Re: Ben Graham's Equation Date: 10/31/2001 6:43 PM
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Hi Bogey,

Do you agree that the intrinsic value of a share of stock is the future free cash flows attributable to that share of stock, discounted back to the present at some appropriate rate?

In my experience that's a pretty well agreed on definition of intrinsic value. If you have another definition I'd love to hear it.

If you agree that this is the case, then I guess the question is whether your goal is to invest in companies at a price below your best estimate of intrinsic value with the expectation that the price will rise eventually to reflect your estimate.

If you think this is the right way to invest, then I'm just mystified by this statement:

The problem with DCF, in my mind, is that with so many proponents of it, everyone is looking at it. It's not like a company's intrinsic value is the great unknown to people who follow DCF religiously.

If the companies intrinsic value is known, and it's less than the stock price, then why not buy the stock? (Assuming a suitable margin of safety.) If the stock price is above intrinsic value, then it seems strange to curse the messenger (DCF) and to search for some other approach to investing.

I mean, you're either investing to take advantage of discrepancies between your estimate of intrinsic value and the market price, or you're not. If you're not, then the column on Graham seems a bit out of place. If you are, then how can you argue that DCF isn't the right path to estimating an intrinsic value?

As Snoop and Howard pointed out, there are huge variations in intrinsic value that are dictated by the assumptions of any DCF analysis. Your goal is to do a better job at it than others.

I think that having shortcuts to make a quick assessment of whether a stock might be trading below intrinsic value is very useful, and perhaps you can argue that this formula is one. But it seems pretty important to then follow up on a shortcut with more due diligence, and in my mind that means DCF.

Just my two cents.

-john

ps: I can't offer a citation, but I could swear that Graham's formula was his attempt to estimate the PE that an investor might expect to see for a solid growing company, and was not actually a shortcut to intrinsic value.
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