Below is a summary of what I do to try to determine whether a company is fundamentally good value or not.
Basically I go through a series of 5 tests and a company has to gain a score of 70%+ in these tests for me to rate it as ok to buy fundamentally. I've set up an Excel spreadsheet to model these 5 tests. Then I look at the company's price chart to help time buying points if the stock passes my funamental tests.
1) I use the Altman-Z Factor to gauge whether a company is financially sound or not. For info on how the Altman-Z Factor model works, maybe have a look at http://www.nysscpa.org/cpajournal/old/16641866.htm
This test has a 25% weighting to the final score.
2) I look at various financial ratios including, working capital ratio, Debt/Equity, Gearing, ROA, ROE, interest cover, dividend cover, EBIT margin etc
This test has a 22% weighting to the final score.
3) I then look at the PER and PEG ratios to make sure they are within reasonable limits.
PER and PEG each have a 10% weighting to the final score.
4) I then look at what total returns (cap gain + divs) I can expect in the next 2 years based on increased share price according to PER and EPS,DPS forcasts. I aim for at least 10%pa potential return.
This test has a 23% weighting to the final score.
5) I then discount that total return back to NPV to see if the current share price is above/below the NPV.
This test has a 10% weighting to the final score.
Current Share Price: $1.00
Forcast EPS in 2 yrs: 7.5 cps
Forcast Div in Yr 1: 3.0 cps
Forcast Div in Yr 2: 3.2 cps
'Fair' PER: 16.0
Long term 'Risk Free' Return: 5.5%
Therefore, potential price target = 0.075 x 16.0 = $1.20
Potential TOTAL 2 yr return = $1.20 + 0.03 + 0.032 = $1.262
Now I 'discount' this $1.262 total return back to NPV using a transposed compound interest formula:
NPV = TR/((1+I)^n)
NPV = Net Present value of the $1.262 total return
TR = Total Return
I = Discount Rate
n = number of years
^ = to the power of
NPV = 1.262/((1+0.055)^2) = $1.13
Since the current share price at $1.00 is well below the $1.13 NPV of my total potential return then I would consider XYZ to be good value atm. But to pass my NPV test, the share price has to be at least 10% below the NPV. The current share price having to be 10% below NPV is my risk premium as compensation for buying the shares and not simply investing the funds at the 'risk free' interest rate.
So although all this above doesn't actually value the company, it does value my expected returns in terms of what those returns are worth today (NPV).
So after I have the results of the above 5 tests, the individually weighted test results need to add up to a score of 70%+ for the company to pass my fundamentals/valuation test overall. If the company passes then I look at the price chart to help time buying points.