In the last investment post I wrote a checklist to stock investing. I described how I do my homework to see if there are growth prospects for a particular stock in the future. Once the answer to that question is yes, the next thing I look at is the current stock price.

Although a company may have solid performance, there stock may be overvalued and might be expected to fall again. Just as there are methods to evaluate a company, so are there methods to evaluate when to buy. After all, the price you are paying ultimately determines the rate of return that you’ll be earning.

Calculate the intrinsic value

To find our sweet spot price, called the intrinsic value, we will need some numbers. I can’t stress this enough, if you have bad numbers you’ll get bad results. Garbage in, garbage out.

That said I will tell you where to find each of the numbers you’ll need. It is important to understand that there are several ways of calculating intrinsic value. I am showing you the most common method using discounted earnings, but you could do similar calculations with discounted cash flow or discounted dividends.

I wrote a quick calculator to handle all the math for you, but if you want to peek under the hood, all formulas were taken from How to Calculate Intrinsic Value for Stock Investing the Warren Buffet Way.

EPS on TTM
You can use Yahoo!’s Diluted EPS (ttm) or a normalized EPS for MRFY (which I have with Scottrade).

EPS growth rate
This figure is an estimate of what you expect the EPS to grow to after X years. There are many answers to this and each will give you a slightly different end result. Usually I’ll plug a few in and average my results. I will tend to use Yahoo!’s Next 5 Years growth estimate, but you can also take an average of the EPS for the past 10 years or use the past 5 years. You can also listen for a prediction from the CEO of the growth rate of the business. I would tend to use the lower of these numbers. After all, we don’t want a best case, unrealistic number. And who knows the business better than the CEO?

Expected PE
Similar to the EPS growth rate, this will be an estimate. I will usually take the LESSER of the average of the PE for the past 5 years or twice the EPS growth rate.

Expected ROI
This is simply you minimum acceptable rate of return. For me, I don’t want to settle for anything less than 15%.

Intrinsic Value Calculator





Look at analysts’ predictions

I also like to look at what the analysts’ opinions are for the stock. Again, I use Yahoo! Finance for this. There predictions better be higher than the current price or what’s the point?

Feedback?

I am a fairly new investor, so if there are other ways to slice the data that you think are important please post them here. I’m interested to hear how others do their due diligence.