To whom is this article for?

This for people that familiar with basic concepts of stock market investing but want a method to quickly analyze valuation and estimate return. This method will require use of computational tool. This will help you to value difficult stocks like Amazon with crazy PE value or simple dividend grow stocks like REITs. Demonstration is made with commercial software but there is no complex math involved so crafty persons can code them if they can access the data.

Basic philosophy of the method

Value investing is one of the more popular generic themes in traditional stock market investing. Warren Buffett is the most famous and one of the most successful value investors. Buy low and sell high is what all investor know is what must be done to hedge risk , but to execute that with accuracy needs something more than old saying you hear from everybody. Here is methodology that I have used successfully for couple of years. The following method utilizes following concepts

Intrinsic value
Historical valuation
Analyst estimates
Total return
Mean reversion

In very short form the method utilizes historical valuation to find intrinsic value and compares that to analyst estimates which can be used to estimate total return when mean reversion occurs. Don’t worry! I will explain what that all means in detail in following chapters. By no means I claim that following method is my invention but more like accumulated information from many sources but mainly from Chuck Carnevale from seeking alpha.

Intrinsic value

Intrinsic value is a concept of value of stock that is something different from currently openly traded value. This is related to talk when people tell that stock is expensive of cheap as their own definition of intrinsic value is different from current stock price. So everybody can have their own intrinsic value for stock, hence the stock trading up or down. Instead of trying to 2nd guess how to best calculate stock valuation from quarterly statements and for example estimated future cash flow, I will show how to market can tell us from intrinsic value, and whether stock is trading up or below it. In the end it does not matter what ever I think of value of single stock as long as 90% of market does not think so and price gain never materializes. So we need to analyze how market values the company.

Historical valuation

Historical valuation is simple concept. We need to just draw how company stock has been value in history. Here is example of P/E value of S&P 500 index in history

*/http://www.multpl.com/

And similarly to other factors if they are meaningful for the stock. However I think this type of curves are not useful in raw format like this. I want to use averaged(over a period like 10 years) valuation curve and multiply it with relative change in earnings.

For example for McDonalds(MCD)

Calculated curve has starting point locked with average P/E ratio over the period.(18.2) The 2nd value is calculated by multiplying previous value with percentage change of EPS. Meaning that we assume that intrinsic value increases in fixed relation to change in earnings. And we get the yellow valuation curve like that. That curve is an intrinsic value candidate for the stock.

Analyst estimates

Analyst e