Among various investment strategies, the Value-based approach was one pioneered by Benjamin Franklin and adopted by Warren Buffet over the decades. In the end, what matters in equities investing is the price you buy a company’s stock and at what price you eventually sell the stock. Everything else in between is noise which could be macro-economic trends or world events that disrupt normalcy as war conflicts, pandemics, or downturns in specific market sectors. Value-based investing is about finding a real intrinsic value of a stock whose growth story you have a conviction on and riding that conviction up to a point where you ultimately realize your profit goal in the long term. When investors talk about buying on dips, they do not necessarily imply buying every stock at the dip. That would be like catching a falling knife. Instead, they are suggesting buying good stocks at the right or discounted price.
Phil Town is a renowned American Investor who wrote the best selling book Rule #1 The Simple Strategy for Successful Investing in Only 15 Minutes a Week which talks in detail about Value-based investing. Rule #1 is about “Don’t Lose Money”. This investing approach comes down to four steps:
- Find a wonderful business
- Know that it’s worth as a business
- Buy it at discount.
- Repeat until very rich.
The book talks about the Four Ms –
- Does the business have Meaning to you?
- Does the business have a wide Moat?
- Does the business have great Management?
- Does the business have a big Margin of Safety?
This post is a practical translation of Chapter 9: Calculate the Sticker Price. The Sticker Price, as Phil explains, is the “correct value” price for the stock at the current moment determined by taking into account its past growth, the future expected growth, the margin of safety (MOS) to set aside for the purchase price, and your investment timeline. On the last point, Value-based investing applies only to long-term investing. Phil talks about the 10-10 rule. – “I won’t own this business for 10 minutes unless I’m willing to own it for 10 years.”
I highly encourage you to pick up the book. Not all of the explanations can be captured in a single post. You will probably appreciate the subsequent section on the practical approach even further once you get familiar with the underlying arguments.
Now let’s get into a practical way to arrive at the Sticker Price of any stock. We need four numbers handy:
- Current EPS (Earnings Per Share)
- Estimated (future) EPS growth rate
- Estimated future PE (Price per Earning ratio)
- The minimum acceptable rate of return from this investment.
If you are a beginner in investing and not very familiar with the terms EPS and PE, I suggest searching for these terms online for a quick understanding. In short, EPS is the profit the stock unlocks, and PE is how expensive is the stock for every unit price of profit it gives. Also, to put it differently, they are just the inverse of each other, and EPS x PE essentially translates to the market capitalization of the stock.
Based on the approach elaborated in the book Rule #1, I have created a CALCULATION SHEET (you can open it directly in Google Sheets, or download and open it in Microsoft Excel, or Numbers on MacOS). All you need to do is pick up four pieces of information for a stock of your choice from financial websites (I have suggested links to them) into each editable column field, and let the formulas auto-calculate the Sticker Price!
The Editable fields are the ones you just need to fill in. The comments alongside show where you can obtain this data.
| Past EPS | Historical Equity Growth Rate 1. Goto https://www.screener.in/ 2. Search for the Company 3. Pick the “Return On Equity” data (not EPS growth!) for Last 3 Years.  |
| Forecasted EPS Growth Rate | From any analyst websites. (If you do not have any definitive source of information here, just leave it aside. |
| EPS Growth Rate | Minimum of (Historical Equity Growth Rate, Forecasted EPS Growth Rate) |
| Current EPS | 1. Goto https://www.screener.in/ 2. Search for the Company 3. Pick the EPS TTM data from the Profit & Loss Section  |
| Future EPS | Current EPS * (2 ^ (YOI / (72/EPS Growth Rate))) |
| Default PE | 2 x EPS Growth Rate |
| Historical PE | Pick TTM PE from https://www.moneycontrol.com/ stock page |
| Future PE | Minimum of (Default PE, Historical PE) |
| Future Market Price | Future EPS x Future PE |
| Sticker Price | (For 15% MARR & 10 yr YOI, it evaluates to roughly 1/5th of Future Market Price) 1. Years To Double Investment = 72/MARR 2. No. of Doubling within YOI = YOI/(Years To Double Investment) 3. Sticker Price = Future Market Price * (1/(2^No. of Doubling within YOI)) 4. Applying Margin of Safety, Safe Sticker Price = MOS/100 * StickerPrice |
The Sticker Price calculation I have in the sheet may be slightly tricky to interpret, but it is just plain logic. What the formula does is use the time taken to double your investment and your investment duration, it then backtracks the formula (applying reverse exponential in mathematical terms) from the future anticipated market price, and finally applies a safety margin on the derived Sticker Price.
At the top of the sheet are the key requirements that you need to enter. Remember the 10-10 rule even if your investment horizon could be slightly smaller, and be realistic about your expected returns.
To summarize, here would be some key takeaways from the number you finally obtain for the stock –
- It is based on estimates such as the historical growth of the stock, and forecasted growth estimates. That’s the nature of every stock analysis (at least for a longer duration)
- A lot of stocks trade at a high PE ratio. These are typically growth stocks, many relatively nascent in the industry. Growth may not be sustainable in the very long term, so I would typically apply Value-based investing on proven well-established stocks over a decade or more, not on any fledgling growth stocks.
- Many times, applying a 50% Margin of Safety can at times lead to a Sticker Price which you would probably never get a buying opportunity (unless a situation of drastic dips such as a pandemic or other macro events). I would still keep it close to 70-80% or less in today’s world where everything is valued high in the anticipation of growth.
- When a stock is overbought, this exercise could also help you in managing the exit point of some of the unrealistically valued stocks. For example, if a stock is currently trading at 5x or 10x of the Sticker Price, it is a signal that one should be paying attention to!
Value-based investing is a way of long-term investing. Mutual funds in Equity: Value Oriented categories fundamentally follow intrinsic Value evaluation techniques for the portfolio of stocks. If you are patient enough to play the long game, you might also want to go via the Mutual Fund route of checking Equity Value Oriented Mutual funds as listed here.
Value-based investing has been a long proven investment technique for big investors. When these investors had billions of dollars at stake, they can hardly afford to take short term speculative measures. They play the long game, and look for the right buying opportunities to up their stake in the game.
