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Tagged: Intrinsic value

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Sig,

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Regards,

David. S

Hi there, please be patient with me, I haven’t taken a math course in 20 years….

I keep getting stuck on the beginning of 2.1 Discounted Cash Flow. I get the concept, but the numbers I get are slightly different. Perhaps I’m accounting for inflation incorrectly – can someone help me?

It’s the first example of a stock generating $100 per year over three years.

As Stig explains, we must account for 2 percent inflation.

He gets a figure as the value of $100 after three years being $94.23

And the value of the stock today being $288.39

I get the concepts but I’m not getting those numbers…

How do we arrive at $94.23 after 3 years? Are we multiplying .98 by itself for 2-3 years to account for inflation rate of 2 percent? I don’t get a figure of 94.23.

And I’m also unclear on how we get to the figure of $288.39 for the value of the stock today.

Can Stig or someone explain step by step how we arrive at these figures?

Again, I get the concepts, but I’m not arriving at the same figures so I must be doing something wrong. And please take it easy on me – it has been 20 years since my last formal math class ðŸ™‚

John,

The discount factor of year 3 can be calculated as 1/(1+0.02)^3 = 0.9423223345

If you multiply this number by the payment for the period ($100) you get $94.23The reason why the discount factor is calculated this way is straight from the Future Value formula:

FV = PV * (1+r)^years

PV = FV / (1+r)^yearsIn our case FV = $100, r = 2% and years = 3.

Hope this is helpful.

Hi,

I just finished your Intrinsic Value course and have been looking into some stocks via the TIP Value Multiple filter. I decided to further filter the companies by ensuring that their P/E x P/B < 22.5 as taught in one of your free courses. However, I find that most of the companies in the Value Multiple filter don’t get past this second filter.

Is this approach incorrect? Should I not use this second filter if I am already using the value multiple filter?

Hi John,

Great question!

So we discount the numbers with three different factors.

100 discounted with 1.02.

100 discounted with 1.02^2.

100 discounted with 1.02^3.When we do that we end up with 288.38 in total.

Please let me know if you have any follow up questions.

Thanks for the support!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

CiamÃ©,

I don’ think that is an incorrect approach. Rather I would say that TIP Value multiple is a better number. If you think about it you use a more advanced method of P/E and P/B by doing so, so there is no need to put in another layer of factors like these to filter the stocks.

EBIT is a better measure of “earnings” and EV better than B and P.

Thanks for taking the course and the support!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

Tal K,

Oh – didn’t see you already responded. Thanks a ton!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

Where can I find the TIPmoney site?

Pep,

We’re still working on it! So sorry for the delay!

Happy Thanksgiving!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

Hi Stig,

I have two questions:

1)

Let’s say we use both IRR and DCF techniques.For IRR: we get 8%. Comparing this to the S&P500 expected return of 3%, this is a pretty decent trade.

For DCF, we discount by 8% and get the same valuation as the current market price. This would be considered fairly valued and wouldn’t justify going long on this position.

My first question would be, with respect to the two scenarios cited above, are they both producing the same valuation? If so, how can IRR recommend going long and DCF recommend not doing anything? Please clarify my misconceptions here

2)

To further develop on my IRR scenario in question 1 (IRR indicates 8%). Let’s say I decide to go long on the stock. What would be my target price? My assumption is a price that will produce an IRR the same as the expected return of the market. If I’m right about the target price being a certain IRR target, how does this IRR target defer between declining, stable and growth companies? I would assume it would highest (above market rate) for declining, on par with the market rate for stable and lowest (below market rate) for growth. Would like to hear your view on this.Anyway, thank you so much for the course. It really helped clarify a lot of misconceptions I had about intrinsic valuations. Alas, please correct any misconceptions I have here as well. Thank you and keep up the fantastic work!

Hi Daniel,

First of all, thank you for taking the course. Highly appreciate the support. As you can likely tell, it’s how Preston and I can afford to create free content for everyone – so thank you for not supporting us, but rather the TIP Community.

Question 1)

I would like to make make sure we’re on the same page here. The 3% you talk about for the S&P500. Is that the Schiller P/E you’re talking about?

IRR is basically just saying what should you discount the future cash flows with to get the current market price for that security. You typically do not do DCf for S&P500, but you could if you had the data.

Please allow me to wait for your response before I can properly respond to your question 1 and 2.

Thank you!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

Hi Stig,

Yes the 3% I’m talking about is with reference to the Shiller PE multiple

Daniel,

Thanks for getting back to me.

1) So the 8% is for the individual stock, and the 3% is found using Schiller P/E. If I understand you correctly then yes, the would invest in the individual stock. The IRR for the stock is 8%, and Schiller P/E is simply derived differently. You could, in theory, do a weighted IRR of S&P500 if you use the assumptions behind the Schiller P/E and say that given the expected cash flows, it would be 3%. It is a tricky thing because you’ll also do an IRR (just the flip side of DCF), of companies when analyzing S&P500 with negative cash flows where you by definition can’t use the approach.

2) To calculate the target price I would adjust the sheet you’re working with, and see what kind of return that would be attractive to you. Say 8%. I disagree in your assumption that it would yield the market return (3%) since you just found it to be 8%. The difference is because of the future expected cash flows.

I would require a different IRR dependent on the type of company like you are getting at. Higher for worse companies, but it’s more an art than a science. As much as I would like to say 12% for bad, 10% for fair, and 8% for excellent companies it would be too simplistic.

I hope you found my responses useful.

In any case, you’re always welcome to ask additional questions.

Thank you again for your support!

-Stig

Price is what you pay. Value is what you get. - Warren Buffett

Hi Stig,

To follow up on your answers…

1) you said you would invest in the stock if the calculated IRR of the stock is 8% when the expected return of the market is 3%.

However, if we were to DCF the stock based on an 8% discount rate, we would be told by the model that the stock is fairly valued since the calculated intrinsic value is the same as the market price.

These two scenarios are basically coming to the same intrinsic value just through different methods. I find it a bit odd that the IRR method would recommend a position and the DCF method would recommend not going in.

Or could it be that to further refine the decision making around the IRR model, we should when the model produces an IRR that is above the annual return investors would demand from it based on its individual risks?

2) With regards to ‘I disagree in your assumption that it would yield the market return (3%) since you just found it to be 8’:

To clarify what I meant in (2), my assumption of how to get a target Price for IRR model:

After calculating the IRR of the stock, I leave the FCF projections untouched and start raising the current stock price until the calculated IRR becomes the expected return of the market. Would this be a fair way of obtaining the target Price?

Thanks once again for answering my questions Stig, I really appreciate it!

Hi Stig, Daniel,

I’m enjoying your thread about (what I perceive to be) the distinctions between the “discount rate” and IRR.

I enjoyed the Intrinsic Value Course and am in the process of taking a few of the lessons a second time in order to make things click.

I made the following memo yesterday while reviewing lesson 2.3, I think it may be relevant to this thread:

**MEMO FROM 12.12.18- after going back through a few lessons a second time**I think it may have just clicked for me: the relationship between discount rate and IRR. If I first judge that a discount rate of 15% is appropriate for projected future cash flows–given inflation, opportunity cost, and uncertainty–and then If I use the calculator (or Excel Function) to determine an IRR (based on the exact same projected future cash flows) of 17%, then I can conclude that the current market price is less than the intrinsic value.But by how much?

It would be nice to frame this in terms of “margin of safety” but I’m not 100% sure how. Would I simply say that I can buy the stock with a 2% margin of safety. OR, would I say that I have a 12% margin of safety since 15% is about 12% less than 17%? I would suspect the latter, no? /END MEMO

Any feedback on this would be appreciated,

Regards,

John

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