======Intrinsic Value Formula (IVF)======
The Intrinsic Value Formula (also known as the 'Graham Number' or 'Benjamin Graham Formula') is a simple equation developed by the father of [[value investing]], [[Benjamin Graham]], to quickly estimate a company's [[intrinsic value]]. Think of it as a financial "rule of thumb" or a back-of-the-envelope calculation designed to give you a rough idea of what a business is fundamentally worth, separate from the often-fickle moods of the stock market. The goal isn't to find a magic number that is 100% accurate, but rather to provide a starting point for deeper research. By comparing the calculated intrinsic value to the current [[market price]], an investor can quickly gauge whether a stock might be trading at a bargain or if it's dangerously overpriced. This simple yet powerful concept lies at the heart of Graham's investment philosophy: determine what a business is worth, and then pay a lot less for it.
===== The Formula Itself: Then and Now =====
Graham's formula wasn't set in stone; he even tweaked it himself to adapt to changing economic conditions. Understanding both versions gives us a great insight into how fundamental factors influence a company's value.
==== The Original 1962 Formula ====
In his book //Security Analysis//, Graham first proposed this elegant equation:
**Intrinsic Value = [[Earnings Per Share]] x (8.5 + 2g)**
Let's break down the components:
  * **Earnings Per Share (EPS):** This is the company's profit divided by the number of outstanding shares, usually taken from the trailing twelve months (TTM). It’s the engine of the formula.
  * **8.5:** This was Graham's baseline [[P/E Ratio]] for a company with zero growth. He considered this a fair price to pay for a stable business that wasn't expected to expand.
  * **2g:** This is the engine's turbocharger. The 'g' represents the estimated annual earnings growth rate for the next 7 to 10 years. Graham multiplied it by 2 to give extra weight to growth, but he was always extremely cautious about using high growth projections.
==== The Revised 1974 Formula ====
Graham later recognized a major flaw in his original formula: it didn't account for prevailing interest rates. If you can get a high, safe return from bonds, you should demand a higher return (and thus pay a lower price) for a riskier stock. To fix this, he introduced a revised formula in his book //The Intelligent Investor//:
**Intrinsic Value = (EPS x (8.5 + 2g) x 4.4) / Y**
The new ingredients are:
  * **4.4:** This was the average yield of high-grade U.S. [[AAA corporate bonds]] in the early 1960s, which Graham used as his risk-free benchmark.
  * **Y:** This is the //current// yield on AAA corporate bonds.
This revision brilliantly connects the stock's valuation to the broader economic environment. If current bond yields (Y) are high (say, 8.8%), the formula's divisor is larger, resulting in a //lower// intrinsic value for the stock. This makes perfect sense—why take the risk of owning a stock if bonds are offering fantastic returns? Conversely, when bond yields are low, the intrinsic value estimate for the stock goes up.
===== How to Use the IVF (and How Not To) =====
Using this formula is part art, part science. It’s a powerful screening tool, but it's no crystal ball.
==== A Starting Point, Not a Final Answer ====
The IVF is best used as a quick filter. You can run it on a list of stocks to see which ones pop up as potentially undervalued. If the formula spits out a value that is significantly higher than the current stock price, it’s a signal that the company might be worth investigating further. It is //not// a signal to immediately buy the stock. It’s the beginning of your homework, not the end.
==== The "g" Factor: The Most Dangerous Number ====
The most subjective and easily manipulated variable in the formula is 'g', the growth rate. A slight change in your growth assumption can lead to a massive change in the final intrinsic value. A true value investor, in the spirit of Graham, should be deeply conservative here.
  * **Be Realistic:** Don't plug in the heroic growth rates you hear from company management or TV pundits. Look at the company's historical growth, the industry's prospects, and the overall economy.
  * **Be Conservative:** When in doubt, use a lower number. It's far better to underestimate the value and miss a small opportunity than to overestimate it and suffer a large loss. For stable, mature companies, a 'g' of 2-5% is often a sensible starting point.
===== IVF and the Margin of Safety =====
This is where the IVF truly shines for a value investor. The entire point of calculating intrinsic value is to then apply a [[Margin of Safety]]. This principle, which Graham called the "central concept of investment," means buying a stock for a price significantly below your estimate of its intrinsic value.
For example, if you use the IVF and calculate a company's intrinsic value to be $100 per share, you wouldn't buy it at $95. That's too close for comfort. A value investor would wait until the price drops to, say, $60 or $70. This 30-40% discount provides a crucial buffer. If your growth estimate was too optimistic, if the company hits a rough patch, or if you just made a mistake, the margin of safety protects your capital from a permanent loss.
===== A Modern Perspective =====
Is a formula from the 1970s still relevant today? Yes, but with major caveats.
==== Strengths ====
  * **Simplicity:** It’s easy to understand and calculate.
  * **Discipline:** It forces you to think about the fundamental drivers of value: earnings, growth, and interest rates.
  * **Objectivity:** It provides a numerical anchor that helps you resist the emotional pull of market hype.
==== Weaknesses ====
  * **Oversimplified:** It ignores many critical factors, such as debt levels, the quality of management, a company's competitive advantage ([[moat]]), and [[free cash flow]].
  * **Industry-Specific:** The formula works best for stable, predictable, mature businesses. It is largely useless for tech startups, cyclical companies, or businesses with no current earnings.
  * **Sensitive to Inputs:** As discussed, the output is highly dependent on your 'g' and 'Y' assumptions. Garbage in, garbage out.
Ultimately, the Intrinsic Value Formula is a timeless piece of investment wisdom. It’s not a magic answer, but rather a fantastic tool for framing your thinking, screening for opportunities, and instilling the discipline that is the hallmark of a successful value investor.