The Warren Buffett Way

by Robert G. Hagstrom

Of those, Graham believed the single most important factor is future earnings power. That led him to a simple formula: A company’s intrinsic value can be determined by estimating the future earnings of the company and multiplying those earnings by an appropriate capitalization factor. This capitalization factor, or multiplier, is influenced by the company’s stability of earnings, assets, dividend policy, and financial health. He added a strong caution: The success of this approach is limited by our ability to calculate a company’s economic future, a calculation that is unavoidably imprecise. Future factors such as sales volume, pricing, and expenses are difficult to forecast, which makes applying a multiplier that more complex.