Hi, I have an example, and I guess I would like
to know your opinion of the "intrinsic value" of
Ok, I have two holding companies who simply invest in
bonds. However, because of some screwy new tax law, they
are going to be in cash for the next 3
Ok, company A has access to quality A+ (private
placement) bonds that pay 10 percent, and we fully expect
the interest rates/availability to stay the
Company B can only get bonds that pay 8 percent. Once
again, we totally expect the status
Alright, here is the question, since both companies have
the exact same assets right now, and it is in cash,
do they have the same intrinsic value? (I don't know
the answer to this, but one of your comments
yesterday made me think of it)
You've opened up a can of worms with that
I'm hardly an expert, but if we examine what Warren
Buffett does, we may get an idea.
Buffett determines what an instrument is worth compared
to a bond. First (1) he determine's the instrument's
future worth over a period of 'x' years.
that (2), he _discounts_ this instrument by comparing
it to the U.S. long bond. Discounting is a method
used to compare to instruments that grow at different
If you had $100 that did not grow at all and held it
for one year, it would have a future value of $100
after that year. However, if you discounted it over one
year at 10% (akin to comparing it with a 10% bond),
you'll get something like 90 bucks ($90.91). This means
that if you wanted to have a future $100 amount in 1
year, you should only pay around 90 bucks for it
Conversely, if your $100 grew 20% in one year, it would have
a future one year value of $120. Discounted by 10%,
this would yield $109.09. Again, this would mean that
if you wanted to ensure a 1 year future worth of
$120 bucks you should only pay $109.09
Buffett's intrinsic value calculations is based on one
massive assumption. That is, that the U.S. long bond
yield is the best and safest long-term rate possible in
corporate America; he's probably right.
to your cash question is: it depends. It depends on
what the money will be doing after 3 months and it
also depends for how long will it be doing what it's
doing. I hope that's not too
Basically, lets assume that after 3 months the bonds just
sit as dead cash. To determine it's intrinsic value
after 1 year you would find the future value of a bond
that grew at 'x'% for 3 months and then grew at 0% for
the next 9 months. This would yield a future value
for one year. You can then discount (compare it with
the long bond) it back at current interest rates.
However, with such a short-term outlook the difference
between it's intrinsic value and flat $100 value will be
negligible, but over longer terms, the difference would be
So, in the first case where, say $100 is
growing at 10% for 3 months and then sits dead for the
next 9 months, it's future 1 year value would be
around $100 + $100 x (3 months x 10%/12 months) x 3 =
$102.50. Discounting back by the U.S. long bond (lets
assume a nice round 6%), you get an intrinsic value of
$96.70. This is after 1 year. If it sits as dead cash for
longer than 9 months, this value will drop. Alas, the
ravages of time works both ways - do nothing and your
buying power erodes.
It is probably safe to use
the long bond rate at 6% for one year because the
time span is so short. However, Buffett realizes that
_historically_ the long bond is much higher and has even been
twice as high. This would _dramatically_ change your
discounting process because a 5% yeild and 14% yeild results
in _vastly_ different intrinsic values over a long
time span - say 10 years.
Sorry for the lack of
any concrete answer. :P
Robert Hagstrom calculated intrinsic value in his
book The Warren Buffett Way, but he didn't derive any
mathematical proofs. This was probably to keep it relatively
simple. The equations would show what would happen to the
investment under 3 different conditions:
grows faster than the company
2) bond grows slower
than the company
3) bond grows at the same rate as
Hagstrom only had examples of when
#2 was true.
After being confronted by an
individual who wanted the proof (I wasn't able to produce it
at that instant), I went back to my desk and
scribbled it out on a scrap piece of paper at work (I
couldn't concentrate after that kind of
Basically it just shows mathematically what is intuitive.
That is, that if a company grows slower than a bond,
buying the bond is more prudent etc.
who wants to try it, just derive the Future Value
forumula (using P=present value, F=future value,
I=interest rate, n=time in years). This formula applies both
for the bond and the company. This is supposedly
Buffett's first method of finding the future worth of a
Then equate both future values F(bond) = F(company).
This is equivallent to 'discounting'.
get to the bottom of the solution you will have three
solutions. I(bond) > I(company), I(bond)=I(company) and
I(bond) < I(company).
I just came into a sum of money to invest in the
market. I have always been a Buffet fan yet never had
enough $ to step up and invest in his stock.
somebody step up and tell me if I should or should not
invest in BRKA at this specif time? Should I wait for
the stock to fall?
I liked your posting on "making predictions."
Consider the prediction that BRK will continue to do well.
After all, it is simply a prediction and may have a
high probability of succcess. But, it is not
guaranteed by anyone (let alone by insurance company such as
Ge... or Ge.....Re). Thus, I only wish that some of the
participants on this post would at least discuss the
possibility that BRK may not do well under certain
circumstances (say, if interest rates go up). Otherwise, we
learn less and are simply the believers like the
ultra-religious people. Even the Roman Empire or the British
Empire came to an end.
Even Buffett (especially
Munger) has talked about paradigm shift. It appears to me
that if Buffett had started investing 20 to 40 years
ago, may be, he would have successfully invested in
steel and auto. He would have made a fortune. But, the
paradigm shifted to colored water, etc. May be, someday,
the paradigm will shift again. Buffett may not be
around by then but ROE on colored water will be smaller.
Of course, if you ask the managers of colored water
(i.e., Buffett and Munger), it is extremely unlikely
that they would say that the stock price is high. I do
not believe that he has EVER (almost ever) has
suggested that any of BRK's holdings are
Furthermore, I only wonder that because the investors have not
had a wonderful time with BRK, they are predicting
the same will be true in the future. BRK will
probably do better than the market (I own a lot) but not
like the last 12 months (or what has happened since
January). Well, these are my thoughts just to keep myself
on ground and I hope some believers are not
The reason is that sometimes we start to believe in a
prediction -- for example, almost everyone (who posts here)
does not want to hear any possibility of BRK not doing
I hate to risk propogating this issue, but my
initial investing concept was firmly based on "not
gaining or loosing" until you actually sell. But after
going through some rounds of wins and losses, I finally
came to the conclusion that paper gains/losses are
just as REAL ever.
I attribute NOT selling to
the rulette table while the wheel is spinning. You
sell when the wheel stops. If you choose to take
whatever you have left (gain or loss) and go for another
spin, then you're back in the market! It doesn't make
any difference whether you decide to leave your chips
on the table, (for another round) or take them off
and walk away. You can't look at your significantly
reduced stack of chips, and say, I haven't lost because I
have yet to walk away!
Same thing with
equities. Your chips stay on the table, on the same number,
with the same odds, for many, many rounds....
Making predictions is always dangerous,
especially if they are about the future.
I copied and
framed two pages of shareholder communications that now
hang on the wall of my office. These are from a
Chickasha Oklahoma company called Sentry Manufacturing
Company that manufactured quartz crystals for the
communications industry and for quartz watches. In its letter to
shareholders for the 3rd quarter of 1976 it said in part "Due
to the quartz crystal watch technology I believe the
quartz crystal industry offers the greatest potential
and opportunity of any industry in America Today" .
This was signed by Joe C. Norman, the Chairman of the
Board. However, this upbeat tone did not even last
throughout the next year. In the letter to shareholders in
the 1977 annual report, Mr. Norman tells us that "60
percent of the American quartz industry employment was
lost during 1977...An American watch crystal industry
doesn't exist today." I keep this to remind me to place
very little confidence in the predictions of other
people, especially if they are about their own company.
I must have a funny spellchecker. I know that
Chickasha is not a common word, but why my spellchecker
wanted to replace it with "Chic kasha" is beyond me.
Excellent advice (from BrkRules) to all you short
term & day traders out there...
<<<The first thing to consider is taxes! Every time you
sell your securities, you realize a (hopefully) gain.
This takes a bite out of the performance, especially
if they are short term gains. The more often you
trade, the more this affects
Unless you are a seasoned SOES bandit, stay out of
<<<...big issues to consider before you sell your
securities is to put your assetts somewhere
YUP!! That's why you want to find something where, if
you sell, you want to put it back into the same
security! That, by definition means you never sell...
There is one prediction that is almost certain to
be true some day. Buffett's prediciton that future
performance of BRK will not be as good as past will certainly
come true. I assume that BRK will grow at around 15%
in the future instead of the historical 24%. When
that starts to occur, I think there could be an
extended period of time, 5 to 10 years, when the stock
appreciation would be in only the 10% range as the share price
adjusts to a lower growth rate. Matter of fact, I expect
this to happen. I can live with it but I feel many BRK
holders will be very disappointed.
I am actally
surprised that they have been able to keep up the current
rate of growth as long as they have. The only hope of
maintaining the current growth rate is through larger and
larger acquisitions like General Re. There are many
fewer large companies that Buffett is interested in
than small companies. He will not be able to do a
General Re every year. The man continues to surprise me
but the number of options that he has to work with
decrease as the company gets larger and larger.
Yup! Predictions are for the birds... but even
Buffet was predicting that BRK would not do as well as
it has... and he's been saying that for more than 10
years now... when BRK was trading at around $2000.
At the risk of sounding like a flippy chearleader...
(no offense to you chearleaders) Brk has plenty of
room to grow. The GRN acquision is proof positive. WEB
says his acquisions have to be big to make any
meaningful dent... What will he buy next? Maybe with his $23
billion float, he'll pay cash and buy another company
with a $25 billion float! I hope eventually he'll own
half the US... I want that $900,000 share. Someday I
want the sticker on my dishwasher to say: "General
Electric...A Berkshire Hathaway Company"
just daydreaming... :-o
"If you claim that any assumptions as to what
cash will do is speculation, I agree. However, from
that aspect, any prediction of future income/value is
also speculation, no?"
Yes. And the less you
do, the better. It's already bad enough that you have
to forcast earnings and return on equity for 10
years without having to throw in other garbage as
The Toronto Investment
"Would you agree that cash has a "real" intrinsic
value based upon how it is actually used? (eg, if one
calculated intrinsic value in hindsight)"
face-value intrinsic value. Once it is used, it is no longer
cash. It becomes something else with different
"Since that number is actually
worthless, if I understand you correctly, you are stating
that assuming a value greater than face value is
dangerous. Also, if the true intrinsic value of the cash is
less than face value, hopefully we aren't investing in
Cash is not worthless. Cash is
stated as face-value. No more and no less. $100 now is
worth $100 in present value terms, that's all I'm
saying. Sometimes a rose is just a rose. What cash 'was'
or what cash 'will be' is total