The overall process of investing is simple: Buy – Hold – Sell. Unless you’re a buy-and-forget investor, it makes sense to periodically check on the difference between the price of your investment and your estimation of its intrinsic value.
One small complication in this process is the fact that the intrinsic value of every company changes over time. It’s hard enough to come to a sensible estimate of value, and it may be even harder to estimate value once you actually own a company’s shares because behavioural economists tell us that we are more likely to value things more highly once we own them.
Many investors feel the need to re-think their investment’s value almost constantly by following every piece of news and factoring it all into their latest estimate. However, if a company needs that sort of close attention, or has an intrinsic value which is so sensitive to the day-to-day events that happen to all companies, then perhaps it wouldn’t make such a good investment after all.
Alternatively, a large, mature and stable company is more likely to have an intrinsic value which is better insulated against the ups and downs that all companies face.
The intrinsic value of a good business typically takes time to change, which is why the annual report may be the best time to do a revaluation.
Looking at BAE (a company which I’ve owned since early 2011) as an example, I can compare the key numbers which make up my valuation in order to see how they’ve changed in the last year.
- For 2010 the average earnings for the previous ten years was 26.6p. For 2011 it was 28.4p, an increase of 6.7%.
- For 2010 the 10-year earnings growth rate was just under 8%. For 2011 it’s just over 8% after a negligible change.
- For 2010 the dividend was 17.5p. For 2011 it’s 18.8p, an increase of 7.4%.
Using these simple long-term fundamentals, I think it’s reasonable to increase my estimate of BAE’s intrinsic value by something around 7%. Alternatively, I can combine value with price and look at the long-term earnings yield and the dividend yield to see if BAE is good value for money at the moment.
Of course, there are thousands of other factors that can be considered, and after I’ve read through the annual report, I might think about some of them in more detail. However, the truth is that even if I learned more about BAE than the company’s CFO, it’s unlikely that that knowledge would give me much more of an investing edge than just a handful of key long-term metrics.