As most of the fundamentalist prefer using the Discounted Cash Flow in their Company valuation, I personally uses this particular method, which I call it, the Discounted EPS method.

Valuating a company’s value is not an exact science.

As a person which is not from a financial background, I personally find the Discounted EPS method makes more sense to me, and thus, I just stick to this way.

Basically, the brief idea of the whole method is listed below:-

1. Estimated the future EPS growth rate.
  • Look for the past 10 years EPS growth rate.
  • Based on your own judgement, determine a growth rate which you think the company will be growing in the next 10 years.
2. Calculate the estimated EPS in year 10 from now.
  • Use the current latest EPS.
  • Compound it with the estimated growth rate for 10 years.
  • We want to have a feel of what will be the EPS of this company after 10 years from now.
3. Decide an average PE value.
  • Look back on the past 10 years PE value for this company
  • take the average PE value.
4. Calculate the estimated Share Price in year 10 from now.
  • Multiply ‘Step 3′ & ‘Step 2′, and we will get the estimated share price in year 10.
  • That’s the share price most likely the company will be trading at after 10 years. Get a feel of it.
5. Decide an annual return rate that you want to get from this investment.
  • This is basically the same as the Discounted Rate mentioned in the Discounted Cash Flow.
  • My personal goal is to earn a 15% return consistently every year from all my investment, thus, 15% is the discounted rate which you will see me using in all my stocks valuation.
6. Calculate the Company’s Intrinsic Value by discounting the year 10 stock price back into present value.
  • Use your rate of return that you’ve decided in step 5 as your discount rate.
  • Calculate the present value of the stock using the Discounted rate.
  • This will be the Stock price that you should be paying if you want to get a consistent annual rate of return that you have decided in step 5.

Easy to understand, right?

It really makes more sense to me.

To me, the money that I pay for the company (Buying price) is directly related to how much return rate I’m willing to accept.

If I’m willing to accept a lower rate of return, then the price of the stock can be anything higher.

But, if I want to earn a higher rate of return, then the company’s stock price has to be at a very low price in order for me to achieve that.

Make sense?

Step 1 – Step 4 actually forecast where will the stock price be trading 10 years from now.

While Step 5 & Step 6 determines what price you should be buying this stock, assuming that you want to achieve the rate of return that you’ve determined, and that the stock will actually trade as your forecasted price after 10 years.

We do not really care what’s the value of the company.

What matters most to us, is how much rate of return that we will be getting!

Let’s go through a real case study, by using the same company as we’ve used for the DCF method, Apollo Group.

1. Estimated the future EPS growth rate.

Here’s the Earnings Per Share for Apollo Group for the past 10 years.

Let’s calculate the past 10 years annual compounded growth rate for APOL’s EPS.

Using the compound calculator, we get that the annual compound growth rate for APOL’s EPS is a whoooping 26% !

2. Calculate the estimated EPS in year 10 from now.

By using the same Compound calculator to calculate the future EPS, we get that the future year 10 estimated EPS for APOL will be at around $42.

3. Decide an average PE value.

A look into the average PE for APOL for the past 10 years …

… and we can say that, the average PE for APOL for the past 10 years is somewhere around 30.

4. Calculate the estimated Share Price in year 10 from now.

Thus, getting an estimated share price for APOL in 10 years from now will be easy.

EPS x PE == Share Price

And that will be $1260.

5. Decide an annual return rate that you want to get from this investment.

For me, that will be a 15%.

6. Calculate the Company’s Intrinsic Value by discounting the year 10 stock price back into present value.

Now, this is getting interesting.

We need to Discount the future 10 year’s $1260 stock price back and reflect it’s present value, so that we know what is the price that we should be buying this stock in order for us to achieve a 15% rate of return.

By using back the same compound calculator, we can the Present Value of $311.

7. The easy way out.

Now that’s for you to understand the whole process of this method.

Once you are pretty familiar and comfortable with it, you can skip by all the pain of using the compound calculators, and dive straight into using the Discounted EPS Calculator that I’ve created.

Just plug in the correct numbers and values, and this is the final thing that you will get. :)

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tag : invest, stock, market, warren, buffett, value, growth, long, term, fundamental, analysis, discounted cash flow, dcf