Save Research Time With PIV-ER

The beginning of a new year is a time to reflect and plan. While last year's investing results were good, there were too many companies to study and too little time. With interesting ideas coming from all directions -- Web sites including RealMoney, television, the gym, you name it -- only insomniacs can stay abreast of the market these days, it seems.

To improve my research productivity, I devised the Earnings Power PIV-ER test a few months ago to give me a quick, conservative measure of a company's real worth. By estimating a firm's intrinsic value, PIV-ER helps me determine whether the risk-return mix justifies spending a few hours running the financial statements through my Earnings Power Chart and also assessing competitive advantage.

Specifically, PIV stands for price-intrinsic value and ER for expected return. PIV is a measure of downside risk, and ER gives a sense of upside potential. The lower a stock's PIV and higher its ER, the better.

How to Build It

You need four pieces of data to build a PIV-ER test. To illustrate, let's use Wal-Mart (WMT - commentary - Cramer's Take). I took these numbers from Yahoo! Finance earlier this week.

• Current stock price: $48
• Earnings per share (trailing 12 months): $2.62
• Book value per share: $14
• Annualized growth, five years: 13.0%

Use those numbers to construct three scenarios, as in the table below. The High scenario has Wal-Mart's earnings growing at the consensus estimate, 13%, for the next five years. Because analyst estimates are unreliable (more on this later), the Medium and Low rates are 75% and 50%, respectively, of the High.

Beginning in year six, I assume annual growth is one-half of the forecasts for years one through five. So High growth slows to 6.5% a year, while Low and Medium are 3.3% and 4.9%, respectively.

Terminal growth, which begins in year 11, equals inflation, which I assume is 3%.

	Low	Medium	High
Growth scenario:
Years 1-5	6.50%	9.80%	13.00%
Years 6-10	3.30%	4.90%	6.50%
Terminal	3.00%	3.00%	3.00%
Intrinsic Value:
Book Value	$14	$14	$14
+ PV Operating value (Years 1-10)	$35	$41	$49
+ PV Terminal Value	$13	$17	$21
Intrinsic value to Common Equity	$62	$72	$84
Weighting	40%	35%	25%
Weighting per scenario	$25	$25	$21
Intrinsic value			$71
Price-intrinsic value			67%
Expected return			48%
Source: Yahoo!, EarningsPower.com

Estimates for intrinsic value to common equity range from $62 to $84 a share. If we assume the chances of the Low, Medium and High scenarios occurring are 40%, 35% and 25%, respectively, then intrinsic value is $71 -- i.e., $25 + $25 + $21.

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At the time of publication, Heiserman had no, although holdings can change at any time.

Hewitt Heiserman conceived the Earnings Power Chart and the Earnings Power Staircase. A graduate of Kenyon College with distinction in history, Heiserman is a member of the Boston Security Analyst Society and the CFA Institute. He also authored It's Earnings That Count. For additional information, please visit www.earningspower.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Heiserman appreciates your feedback; click here to send him an email.

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