I took this saying to heart many years ago, and I wanted to share a piece of wisdom—which I learned a few years ago and recently saw again in a YouTube video—with the younger investors here.
At what price should a value investor buy a stock? Here’s a very simple explanation:
1. Take how much money a company earns per share → EPS (Earnings per Share)
*It’s best to use the normalized EPSso that one-time effects don’t skew the picture.
Example: $GOOGL (-0,01%) has an EPS of €20
2. You look at the last 10 years or estimate the next 10 years and calculate the EPS growth rate → Estimated 10-Year EPS CAGR
These days, ChatGPT can also help run through various scenarios and assumptions.
Example: $GOOGL (-0,01%) has an estimated EPS CAGR of 12%.
3. Calculate what the EPS will be in 10 years.
So: An EPS of 20 € in 2026, assuming 12% growth, would be approximately €62.12 in EPS.
4. You estimate what the company’s P/E ratio will be in 10 years.
This is also called the terminal P/E.
As a very rough rule of thumb, you can use, for example, 2 × EPS CAGR .
With a 12% EPS CAGR, the terminal P/E would therefore be approximately 24.
5. You calculate the stock price in 2036.
To do this, multiply the EPS by the P/E:
€62.12 × 24 = €1,490.88
That would be the theoretical stock price in 2036.
6. Now comes the important part:
If, for example, 15% annual return over the next 10 years, you need to calculate what price you can afford to pay for the stock today.
In this example, that would be approximately €372.72 (stock price / 4)
That would be the so-called intrinsic value
7. It’s best to also factor in a margin of safety.
For example, 20–50% below the calculated intrinsic value, so that you have a buffer for errors in your assumptions.
It all sounds very simple, and the calculation is, too.
The difficult part, of course, is estimating the future EPS CAGR in a reasonably realistic way.
Many factors play a role here:
- ROIC
- Competitive Advantage / Moat
- Balance Sheet
- Cyclicality
- Interest Rates
- Durability of Growth
- Capital Requirements
- Future Revenue Growth
- Margin Trends
- Share buybacks and dilution
- and, of course, valuation
In my opinion, this is exactly where good value investing differs from the simplistic “P/E is low, so I’ll buy” approach.
I’d like to invite many of you to perform a value test on the stocks you currently have in your portfolio. It would be interesting to see which stocks are actually undervalued right now and which ones might simply be good companies purchased at too high a price.
P.S.: Of course, you can also apply this approach to the next 5 years .
For ETFs, you can use a similar approach by dividing the stock price by the respective P/E ratio to get an approximate EPS, and then looking at the historical EPS growth.
For companies that aren’t making money yet, you obviously have to speculate much, much more.
Have fun doing the math! Cheers! 🍻
