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Stocks: Fundamental Analysis
Sample Fundamental Value Investing Plan
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Calculating Intrinsic Value and Margin of
Safety
By now, your search results should be filtered down to stocks with attractive valuation
metrics and a stable price pattern. The last step in your watch list process is estimating
each stock’s intrinsic value and comparing it to the current market price to determine its
margin of safety. This step can be crucial in separating the stocks that appear to be a good
value from stocks that you actually appraise to be a good value.
Download the Intrinsic Value Calculator. Keep in mind, this is for educational purposes only.
The calculator includes instructions on where to find the relevant inputs, but here’s an
overview of the DCF model that you can use to estimate intrinsic value:
1. First, find the projected growth rate. This is based on the company’s actual
annualized growth rate over the last five years. By using the historic growth value,
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you’re assuming the company will continue to grow consistently for the next five
years. To ensure an accurate growth rate, the Reduction Calculator automatically
adjusts the expected growth rate to make your projected growth rate more
conservative.
2. Next, calculate the projected P/E using the industry average P/E ratio. The
assumption is that the industry average P/E ratio is a good estimate of what the
company’s P/E ratio might be in five years. When multiplied by your estimate of
earnings in year five, the exit multiple creates the terminal value—a representation
of the current value of all earnings after year five. Just as the stock’s projected
growth rate was adjusted to be more realistic, the Reduction Calculator also adjusts
the industry P/E ratio—a low industry P/E ratio is less likely to dramatically change,
whereas a high industry P/E is probably untenable for the next five years. Next, to
factor in the time value of money, use the CAPM to calculate the expected
annualized rate of return. As you learned in the previous lesson, there are three parts
to the model: the stock’s beta, the risk-free rate, and the market-risk premium. The
Reduction Calculator dynamically adjusts the market risk premium if the market
experiences higher volatility as measured by the VIX.
3. Finally, input the stock’s current price and EPS for the trailing 12 months (TTM),
which can be found on a stock’s profile page.
4. After entering the data, it’s time to analyze the results. The intrinsic value is an
estimate of the stock’s worth based on your assumptions. The margin of safety is
the percentage difference between your estimate and the current market price. In
general, the higher the margin of safety, the better.
1. Consider adding stocks with at least a 25% margin of safety to your watch list. The
high margin of safety allows for some portion of that profit to be reached, even if
your assumptions end up not 100% accurate.
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In the following video, Education Coach Michael Kealy walks through the last step of
building a value stock watch list: using the Intrinsic Value Calculator and evaluating its
results.
After you have your list of candidates, we’ll discuss sample entry guidelines in the next
lesson.
Activity
By selecting the last five years of a company’s actual annualized growth rate as your
valuation growth rate, what are you projecting about the future?
EPS is likely to grow at the same constant rate for the next five years.
EPS is likely to grow at a faster pace than the industry average.
EPS is likely to grow according to analyst estimates.
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