How to use the calculator?
This is a simple discounted model calculator to help you find the fair value of a company. With a few simple values, you can estimate the rough intrinsic value of a stock. The calculation consists of the following key values:
1. Growth Rate: It is the expected rate at which the company will grow in the upcoming years. Keep a realistic growth rate for efficient calculations.
2. Discount rate: The discount rate is usually calculated by CAPM (Capital asset pricing model). However, many investors use the discount rate as the rate of return that they want to earn from the stock. For example, let’s say that you want an annual return rate of 11%, then you can use it as return rate.
3. Terminal Growth Rate: No company can grow at a fast rate for infinity. Terminal growth rate represents an assumption that the company will continue to grow (or decline) at a steady, constant rate into perpetuity, after the forecasted growth years. We suggest keeping the terminal growth rate less than 3%.
Total Intrinsic value: This is the fair value of stock and equal to the sum of growth value and terminal value.
Always look at the fair value of the company before investing. If the total intrinsic value of a company is greater than the current market price, the stock is undervalued. Otherwise, it is overvalued.
Example-- Let’s say you want to interested to invest in Maruti Suzuki.
The current share price of Maruti is Rs 7463.95(Sept 2018). During the trailing twelve months, the EPS of the company was Rs 260.86.
The first thing you need to do is to find the projected growth. The analysts are saying that Maruti will grow at a rate of 16.56% per annum for the next five years. (Source- Yahoo finance - Go to the stock page and check the ‘Analysis’ tab)
Next step is to find the terminal growth rate. Let’s say that you researched and found out that its terminal growth rate is 2%. Finally, you need to find the return rate. Assume you calculated rate of return using the CAPM model and it turned out to be 10%. Overall, here are the values to be used in the calculations:
- Earnings per share = Rs 260.86
- Return rate (%) = 10%
- Growth rate (%) = 16.56%
- For the period (years) = 5
- Terminal growth rate (%) = 2%
From the above calculations, you will get the intrinsic value of Maruti Suzuki equal to Rs 5997.98.
However, you also need to have a margin of safety on your calculations. After all, the future of any company is unpredictable and these calculations are made on few assumptions. Therefore, let's consider a margin of safety of 15% on the calculated value.
Overall, the intrinsic value per share for Maruti after the margin of safety of 15% is Rs 5098.28. (Quick note: The higher the margin of safety, the safer is the investment.)
As the fair value of the Maruti is lower than the current market price, it may be overvalued right now.