Earlier today I was feeling kinda lonely. 😥 So I decided to buy some shares.
Ah yes. It sure feels good to have a bit of company. 😄 And that company is called Costco.
In this series of blog posts I’ll explain how I determine which stocks to add to my portfolio based on strategic valuation methods. 🙂
How to Value a Stock: The Graham Formula
Today, we’ll look at one of the most common formulas to determine the intrinsic value of a company; it’s call the Benjamin Graham Formula, named after the famous value investor who taught Warren Buffett. 🙂
The Graham formula looks like the following:
This should give us an idea of how much we should pay to buy a stock. Let’s go over the variables.
V = Intrinsic value, or what the stock should be worth today.
EPS = Trailing twelve months earnings per share.
8.5 = P/E base for a no-growth company.
g = Expected long term earnings growth rate.
Is Costco Stock Undervalued or Overvalued?
This formula works best with blue-chip, large cap, value stocks. We will use Costco Wholesale Corporation as an example since I just purchased some recently. 🙂
So to find out the intrinsic value of Costco (NASDAQ:COST) we need to look up the earnings per share (EPS). This information can be found on Google Finance. We see that it’s $5.41.
Next in the formula, we need the “g” value. We can find this information on the Nasdaq.com website, and see that it’s 10.71%.
Finally we can now plug everything into the formula to see the result.
So as of today, March 23rd, Costco should be worth around $162 per share according to the Benjamin Graham formula.
But of course the stock is actually trading at $167. This means Costco is currently overvalued because its shares are trading at a premium compared to the fair value we just calculated.
Nevertheless, I still went ahead and purchased 10 shares of Costco this morning. The 3% premium I paid over the intrinsic value isn’t a big deal for me. Plus Costco recently announced an increase of membership fees to $60 per year. Like most other Costco shoppers I have decided to keep renewing my membership with them. But at least now I own 10 Costco shares, which entitles me (as a shareholder) to receive US $54 of after tax profits every year. This amount converted into Canadian dollars is more than enough to cover the expense of my annual Costco membership, haha. 😀