Intelligent Investor

Last modified 15:43, 5 Oct 2012

The Intelligent Investor

The Intelligent Investor model is in the Value group.

It proposes investing in stocks that are significantly undervalued relative to their Intrinsic Worth, which is measured principally by their Future Earnings Potential.

The model recommends buying stocks of large, prominent and conservatively financed companies with a long record of continuous Dividend payments.

It ignores stocks with Price-to-Earnings ratios of more than 25 times trailing seven-year average annual earnings, or more than 20 times their prior 12-months results. A true bargain was a company whose real value was at least 50% more than its stock price.

The methodology is appropriate for conservative investors worried about the high valuations currently accorded to many stocks, but unwilling to settle for investing only in cash or bonds.

Analysis / Calculation

The following are some of the criteria used in the Intelligent Investor analysis:

Conservative Market Sector

The Intelligent Investor model avoids what it considers to be unreliable or unproven market sectors, for example the technology sector.

Large Volume of Sales

Larger companies are usually more established and better equipped at handling good and bad economic conditions.

Intelligent Investor requires that each company should be “large, prominent and conservatively financed” and uses each company's volume of sales to determine this.

Strong Current Ratio

This indicates that the company is able to cover its short term borrowings with current assets. The Intelligent Investor model looks for a current ratio of at least 2 to 1 (i.e. Current Ratio equal to, or greater than, 2)

Low Long-term Debt relative to Net Current Assets

Long-term debt to net current assets is a measure of liquidity.

When long term debt is less than net current assets, it is a sign of financial health.

Intelligent Investor looks for strong, stable companies and hence requires that long term debt be less than net current assets.

Positive Long-term Earnings Per Share (EPS) Growth

Long term EPS Growth indicates that the company is growing over time.

Intelligent Investor requires that the EPS growth rate over 5 years be at least 30% (not compounded) and that there were no years of negative earnings growth.

Intelligent Investor uses this check mainly to ensure that the company is growing and not stagnating or going backwards.

Moderate Price / Earnings Ratio (P/E)

P/E ratio is a measure or value. A low P/E ratio stock is often viewed as cheap or unpopular whereas a high P/E stock is often viewed as expensive and popular. Intelligent Investor requires that a P/E ratio be moderate and not exceed 15.

Intelligent Investor uses the average earning over the last 5 years to calculate the P/E ratio. The P/E ratio is calculated using the stock price and dividing it by the 5 year average earnings per share number.

Reasonable Price/Book Value (P/B)

The price to book value measure what the market is paying for the net assets of the company. It is calculated by dividing the stock price by the book value. The book value is the assets - liabilities - intangible assets. The lower the P/B value, the cheaper the assets are valued by the market.

Intelligent Investor supports a reasonable P/B ratio which is defined as P/B multiplied by P/E should not exceed 22.

Continuous Dividend Payment

Intelligent Investor looks for companies that have  over the last 5 years continually paid dividends. Failure to pay dividends in one or more of the last 5 years will result in a FAIL.

Note - The Intelligent Investor model is not concerned whether the dividends were increasing or decreasing, only that they were being paid.

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