Good Value Shares
Value of Shares Vs. Price of Shares
Value- The value of a share is determined through data such as net asset value, current and past earnings, and a companies dividend record.
Price- The Price that the share trades at on the Stock exchange.
Grahams investing success was based upon buying shares of high value and low price.
Although it would logically seem that the price and value of a share go hand in hand, they do not- as Graham explains through his "Mr Market" analogy.
In perhaps his most effective analogy Graham invents a figure named "Mr Market" to represent the role of the markets pricing a share. In Graham's analogy Mr Market is a figure capable of enourmous mood swings, incredibly optimistic one day and depressed the next. Graham argues that the "Intelligent Investor" should only listen to Mr Market when it suits his needs- ie he sells shares when Mr Market is feeling optimistic (overvalued prices) and buys shares from him when he is feeling depressed (undervalued prices).
The Job of the intelligent investor is to find shares that possess both a high intrinsic value at a low price- undervalued shares.
The best way of explaining what I am talking about would be to compare 2 companies- one whos shares are overvalued and ones whose are undervalued.
Tullow Oil
Share price:£10.54
Net assets per share: £1.72
Average of Earnings per share over the last three years: 13.28 pence
PE ratio: 79.3
Average dividend per share over last three years: 6 pence.
Forecast dividend yield: 0.6%
Graham argued that investing was most intelligent when it was most business like- Evidently Aviva is the far more businesslike investment- for every £3.18 you pay, you gain a stake in a business that is worth £5.38 on paper alone. Furthermore, for every £3.18 you pay, you would expect the business to return 42.6 pence per year- a very solid rate of return.
N.B- Although Aviva may be a better investment, this does not neccesarily mean it is a better business than Tullow. The investor buying into Tullow oil may own a slice of a terrific business, but he is paying well over the odds for it.
Just as importantly, although Tullow is heavily overvalued, this is not to say the price will not continue to rise. The "Intelligent" investor will recognise that although a further price rise may well occur it is probably not based upon the underlying value of the business improving, rather it is speculation driving the prices higher.
Aviva
Share price: £3.18
Net Assets per share: £5.38
Average of earnings per share over last five years: 42.6 pence
PE ratio: 7.4
Average dividend per share last 5 years: 29.45 pence
Forecast dividend yield: 8.1%
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