Editor's note: A prior version of this article incorrectly stated that the proxy battle at Exar was for control of the board of the company. Only three board seats are being contested. We regret the error.
When you buy a share of stock, you're really buying a tiny piece of a company. Its business becomes your business; its concerns become your concerns. Of course, unless you're Bill Gates or Warren Buffett, your ownership stake is likely only a small fraction of the company's total size. But by controlling that share of stock, you are a part owner of the business behind it.
It really is your company
Once a year, your ownership privileges allow you to decide who will serve on your company's board of directors. In turn, the board decides on the CEO and the rest of the executive team. Generally, investors choose to maintain the status quo -- they probably wouldn't have bought shares in the first place if they didn't trust the management team.
When the motivation is strong enough, however, shareholders really do control the company. Right now, in fact, a proxy battle for control is raging at communications chipmaker Exar (NASDAQ:EXAR), led by dissidents from GWA Investments. If enough shares vote in favor of the opposition, three board seats will be taken over by dissidents.
Of course, just getting an alternative perspective up for a vote doesn't guarantee success. For example, Walter Hewlett led the fight against technology giant Hewlett-Packard's (NYSE:HPQ) attempt to take over former computing rival Compaq. While hindsight showed Walter to have been largely correct in his assessment, the vote simply didn't turn his way. In other cases, however, such as the recent battle that forced Michael Eisner from the helm at Disney, the shareholders' ability to control their companies does eventually prevail.
Make your money work for you
Individual investors usually don't aim to radically change the companies they own. Most of us are simply looking for our capital to appreciate over the long term. Of course, it doesn't always happen that way. If you happened to own Internet pioneer Sun Microsystems (NASDAQ:SUNW) as it peaked during the boom and crashed in the tech bust, you know how easy it is to get lured in by a great business and a rising tide, no matter what the company's stock is really worth.
To be a successful investor -- to know how to make your money work for you -- you need to learn from that mistake. And yes, it'll be far less painful for you to learn from my mistake than it was for me to do the same. The lesson is simple: Every company has a true worth. Buy it for less than it's worth, and you're likely to do quite well. Pay above that value, and chances are you'll soon be feeling the pain.
So, what's it worth?
Of course, that's the key question. In truth, the best way to answer that question is to treat the company just as it treats its own parts. Think about it: A company's goal is to make money. It can have a business model as straightforward as Domino's Pizza (NYSE:DPZ), the ubiquitous pizza delivery chain. Or it can be as complicated as United Technologies (NYSE:UTX), a behemoth that has a hand in everything from jet aircraft engines to air conditioners to security systems to escalators. Whatever its means, the end goal is to make money.
A company decides what businesses to enter based on a simple calculation. It estimates how much money it expects to make in that business for as long as it plans to compete. It then dials back all those future earnings to what they're valued at today. It compares that dialed-back earnings number to what it thinks it will cost to get into the business. If the benefits outweigh the costs, then the company will enter that line of work.
Running the numbers
This is known as a discounted cash flow (DCF) calculation, and if it works for a business -- which is trying to figure out where to invest its money -- it will work for you. If you find a stock trading for less than what its dialed-back earnings are worth today, then it's trading for less than its real value. In that case, it just might be time to buy. If it's trading above its worth and you buy it -- well, then, you run a greater risk of buying the next Sun Microsystems at the top of the dot-com bubble.
This is a time-tested investing strategy, and it's the key method that lead analyst Philip Durell uses at Motley Fool Inside Value. With the help of this technique, he has uncovered two dozen screaming values for his subscribers -- and these companies are no slouches. His picks include veritable titans, such as world renowned megabrand Coca-Cola (NYSE:KO).
How to get started for yourself
If you'd like to know what a stock is worth and use that information to make informed investing decisions, Inside Value can help. The service has its own online DCF calculator that will help you with the number-crunching. If you're already a subscriber, you can access it here. If not, click here to start a free 30-day trial, and try out the calculator to your heart's content. (You'll also have full access to everything we've ever published, as well as to the Inside Value team, who will be happy to help you get started.)
To make it easier for you to get started, you might want to begin with Tempur-Pedic (NYSE:TPX), an Inside Value watch list stock. With the help of these financial records and these estimates, you'll be on your way to finding out whether this bed maker's recent share-price meltdown has opened up an opportunity for bargain-hunting investors.
Are you ready to get started for yourself? Or would you prefer to follow the strategies of a time-tested, market-beating investor? Either way, Inside Value can help.Click hereto start your 30-day free trial.
This article was originally published on Aug. 26, 2005. It has been updated.
At the time of publication, Fool contributor and Inside Value team memberChuck Salettahad no financial stake beyond that of paying customer in any of the companies mentioned in this article. The Fool has adisclosure policy.
