Currently, my valuation of SingTel is based on assumptions of 3 variables: expected growth rate (next 4 years), expected terminal growth rate, and cost of equity. In that analysis, the expected growth rate of SingTel was based off of SingTel’s past growth rates. The problem with such an analysis is that there is a high chance of being wrong; the company may grow at a faster rate, the company may not grow at all, or the company may even see a decline in profits.
Such formulas often have the problem of having too many assumptions built into them, and for an average investors like myself, I don’t have the time and ability to make (close to) accurate or reasonable assumptions about these. Hence, I have finally decided to do away with such complex formulas and try to concentrate on the simpler stuff.
(Ironically, most of the books I first picked up about investing has always recommended layman investors like myself to avoid using such complex formulas. Although I did follow their advice for the longest time, I began to think of them as insufficient. I guess I had to learn it through my own experience!)
From now on, I will only use the PE ratio and an extremely simplified Gordon Growth Model (GGM) to calculated my valuations.
For the GGM, I shall assume zero future growth of the company and value the company based on its current dividend. This makes the formula extremely simple: Intrinsic Value = Current Dividend / Required Rate of Return. I shall not explain the Required Rate of Return (Google explains better than me) but I shall point out that the Intrinsic Value calculated based on this GGM will only be a guide for me to compare against current market prices. Ultimately, whether I am willing to pay for the given market price will depend on my analysis of the company’s qualitative aspects.
For now, I will use a Required Rate of Return at 6%, mainly since it is double the returns from long term government bonds (I am still exploring what level of Return should I expect so do share your thoughts!)
For example, SingTel has market price at $3.25 and dividends of $0.175. From the formula, Intrinsic Value = 0.175 / 0.06 = $2.91667 (vs a price of $3.25). Compared to this Intrinsic Value, the stock is being traded at a 11.4% premium. This means shareholders are paying 11.4% extra for the expected future growth of SingTel. At this point, I will have to make a judgement about whether SingTel’s future growth opportunities and threats are deserving of this 11.4% premium.
Another example, StarHub has market price at $1.93 and dividends of $0.16. From the formula, Intrinsic Value = 0.16 / 0.06 = $2.6667 (vs a price of $1.93). Compared to this Intrinsic Value, the stock is being traded at a 27.6% discount. This means shareholders are paying 27.6% less given the expected future problems in StarHub. At this point, I will have to make a judgement about whether StarHub’s future growth opportunities and threats are deserving of this 27.6% discount.