Bridge over ocean
1 March 1977 Financial Analysts Journal Volume 33, Issue 2

Investment Value and Security Analysis

  1. T. Carter Hagaman
  2. Arnold E. Jensen

“Investment value” is defined as the present value of the stream of cash flowing to the investor, discounted at a rate reflecting the risk of the investment. By estimating investment value and comparing it with market price, the analyst can judge the extent of the investment opportunity in a common stock.

While the analyst may have to review vast amounts of information, only five basic factors enter into his reckoning of investment value: (1) the amount of common equity currently employed; (2) the rate of return required to compensate for risk; (3) the rate of return earned on capital employed; (4) the amount of additional capital to be employed in the future; (5) the investment horizon—the period during which returns on capital employed will exceed the required rate of return.

The authors supply charts demonstrating the relative sensitivity of investment value to changes in investment horizon, growth rate and return on capital employed. The charts demonstrate that growth per se is relatively unimportant; any investment that does not earn more than the required return will not increase the value of the capital employed.

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