Find the Next Winning Stock Using This Warren Buffett Technique

Follow Warren Buffet's lead in creating intrinsic value by increasing your annual earnings while growing the value of your investments and net worth.

Mar 22, 2014 at 1:25PM


At the core of Warren Buffett's investing technique is a concept called intrinsic value. Intrinsic value is important for investors who want to evaluate stocks to see if they are worth buying. I also believe the key factors for building intrinsic value can be used to build personal wealth.

Buffett is so convinced of his own company's intrinsic value that he is willing to buy back shares of Berkshire Hathaway (NYSE:BRK-B) if they fall below 120% of their book value.

"Per-share intrinsic value exceeds that percentage of book value by a meaningful amount," Buffett wrote in his 2013 Annual Report. "We did not purchase shares during 2013, however, because the stock price did not descend to the 120% level. If it does, we will be aggressive."

Intrinsic value components
When Buffett examines intrinsic value, he looks at two very critical aspects of a business.

"The first component of value is our investments: stocks, bonds and cash equivalents. At yearend these totaled $158 billion at market value," Buffett wrote.

The second component of intrinsic value is earnings that come from sources other than investments and insurance underwriting. These earnings are delivered by Berkshire's 68 non-insurance companies, such as BNSF Railway and MidAmerican Energy.

"In Berkshire's early years, we focused on the investment side," Buffett wrote. "During the past two decades, however, we've increasingly emphasized the development of earnings from non-insurance businesses, a practice that will continue."

Intrinsic value is defined by Buffett as the discounted value of the cash that can be extracted from a business during its remaining life.

Benjamin Graham's formula
Buffett's mentor Benjamin Graham developed a formula for measuring intrinsic value. This formula was updated to include prevailing interest rates, but for our purpose, we will look at his original formula. In addition, let's apply the formula to two of the best cash-producing stocks in recent years: Hershey (NYSE:HSY) and Union Pacific (NYSE:UNP).

V = EPS X (8.5 + 2g)

V = Intrinsic Value
EPS = Trailing 12 Months Earnings Per Share
8.5 = P/E base for a no-growth company
g = reasonably expected seven to 10 year growth rate

Based on estimated growth rates of 10% for Hershey, and 7% for both Union Pacific and Berkshire, here are the valuations of those companies based on this formula.


From this method, we can see that Hershey is trading around its intrinsic value, while Union Pacific and Berkshire both offer plenty of upside.

The power of earnings
According to Buffett, earnings will ultimately drive stock prices. Over 40 years, Berkshire's compounded annual gain in pre-tax, non-insurance earnings per share was 21%. During the same period, Berkshire's stock price increased at a rate of 22.1% annually. Over time, you can expect the stock price to move in rough tandem with Berkshire's investments and earnings. Market price and intrinsic value often follow very different paths – sometimes for extended periods – but eventually they meet.

As seen by Graham's formula, this earnings growth is a key determinant of intrinsic value. Much like Hershey and Union Pacific, keep an eye out for those companies that are consistently generating higher and higher levels of earnings over time. As a result, you can then employ the Benjamin Graham formula to derive that intrinsic value and find the right time to jump in.

Michael Hooper owns shares of Berkshire Hathaway, The Hershey Company, and Union Pacific. The Motley Fool recommends Berkshire Hathaway. The Motley Fool owns shares of Berkshire Hathaway. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

4 in 5 Americans Are Ignoring Buffett's Warning

Don't be one of them.

Jun 12, 2015 at 5:01PM

Admitting fear is difficult.

So you can imagine how shocked I was to find out Warren Buffett recently told a select number of investors about the cutting-edge technology that's keeping him awake at night.

This past May, The Motley Fool sent 8 of its best stock analysts to Omaha, Nebraska to attend the Berkshire Hathaway annual shareholder meeting. CEO Warren Buffett and Vice Chairman Charlie Munger fielded questions for nearly 6 hours.
The catch was: Attendees weren't allowed to record any of it. No audio. No video. 

Our team of analysts wrote down every single word Buffett and Munger uttered. Over 16,000 words. But only two words stood out to me as I read the detailed transcript of the event: "Real threat."

That's how Buffett responded when asked about this emerging market that is already expected to be worth more than $2 trillion in the U.S. alone. Google has already put some of its best engineers behind the technology powering this trend. 

The amazing thing is, while Buffett may be nervous, the rest of us can invest in this new industry BEFORE the old money realizes what hit them.

KPMG advises we're "on the cusp of revolutionary change" coming much "sooner than you think."

Even one legendary MIT professor had to recant his position that the technology was "beyond the capability of computer science." (He recently confessed to The Wall Street Journal that he's now a believer and amazed "how quickly this technology caught on.")

Yet according to one J.D. Power and Associates survey, only 1 in 5 Americans are even interested in this technology, much less ready to invest in it. Needless to say, you haven't missed your window of opportunity. 

Think about how many amazing technologies you've watched soar to new heights while you kick yourself thinking, "I knew about that technology before everyone was talking about it, but I just sat on my hands." 

Don't let that happen again. This time, it should be your family telling you, "I can't believe you knew about and invested in that technology so early on."

That's why I hope you take just a few minutes to access the exclusive research our team of analysts has put together on this industry and the one stock positioned to capitalize on this major shift.

Click here to learn about this incredible technology before Buffett stops being scared and starts buying!

David Hanson owns shares of Berkshire Hathaway and American Express. The Motley Fool recommends and owns shares of Berkshire Hathaway, Google, and Coca-Cola.We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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