Three ways to think about value.

How to choose an intrinsic value model

No valuation formula can reveal a company’s exact future value. Each method converts a different set of assumptions into an estimate. The most useful model is usually the one that best matches the company’s economics and the information you can reasonably forecast.

Benjamin Graham Formula

The Graham formula is a quick earnings-and-growth framework. It uses earnings per share, an expected growth rate and an adjustment for the prevailing AAA corporate bond yield. It is useful as a simple screening estimate rather than a complete business valuation.

EPS represents earnings per share, g is the assumed growth rate, and Y is the AAA corporate bond yield used in the formula. Because growth and interest-rate assumptions can change the output substantially, use conservative inputs and compare the result with other evidence.

Dividend Discount Model

The Gordon Growth version of the Dividend Discount Model is designed for companies that pay relatively stable dividends. It estimates value from next year’s expected dividend divided by the difference between the required return and long-term dividend growth.

The model becomes extremely sensitive when the growth rate approaches the required return. For that reason, the required return must be greater than the perpetual growth assumption, and long-term growth should normally remain conservative.

Discounted Cash Flow

DCF estimates the present value of future free cash flow. You forecast cash flows for a defined period, estimate a terminal value, and discount each amount back to today using a required rate of return.

DCF can be flexible, but flexibility also creates risk: small changes to growth, margins, discount rate or terminal assumptions can materially change the result. Sensitivity analysis is often more informative than treating one DCF output as a precise answer.

DCF versus Graham versus DDM

• Graham Formula: fastest screening estimate for profitable businesses when earnings and growth assumptions are available.
• Dividend Discount Model: useful when dividends are central to shareholder returns and are expected to grow sustainably.
• DCF: useful when you can make a reasoned forecast of future cash flows and test several scenarios.

Use a margin of safety

Intrinsic value is an estimate, not a guaranteed future price. Many investors compare an estimated value with the market price and require a margin of safety to allow for forecasting errors, changing business conditions and model limitations.