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Berkshire Hathaway Inc. Message Board

  • BrkRules BrkRules Jul 8, 1998 10:28 AM Flag

    Jim - Dollar is always a dollar?

     

    Hi, I have an example, and I guess I would like
    to know your opinion of the "intrinsic value" of
    it.

    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
    months.

    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
    same.

    Company B can only get bonds that pay 8 percent. Once
    again, we totally expect the status
    quos.

    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)

    This topic is deleted.
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    • You've opened up a can of worms with that
      one.

      I'm hardly an expert, but if we examine what Warren
      Buffett does, we may get an idea.

      Basically,
      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.

      After
      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
      rates.

      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
      today.

      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
      today.

      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.

      The answer
      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
      confusing.

      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
      tremendous.

      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

      JimC
      The Toronto
      Investment Club
      http://torontoinvest.ndsn.com

      • 3 Replies to Rickson9
      • 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:

        1) bond
        grows faster than the company
        2) bond grows slower
        than the company
        3) bond grows at the same rate as
        the company

        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
        challenge).

        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.

        For anybody
        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
        company.

        Then equate both future values F(bond) = F(company).
        This is equivallent to 'discounting'.

        When you
        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).

        Cheers,
        JimC

      • 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.

        Can
        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've read a number of those kinds of statements
      in annual reports. "We plan to use the cash we have
      accumulated over our successful years as blah to consolidate
      our position in the blah".

      I ignore them.
      Why?

      The fact of the matter is, in business, 1 out of 10
      things go through and 9 out of 10 don't. I ran my own
      company for a year before it was bought out and I don't
      really trust projections or speculation.

      As
      Warren Buffett has said in the past, speculation doesn't
      tell you much about the future, but it tells you a lot
      about the speculator.

      In addition, anything of
      significant business value will not be disclosed with such
      blatant recklessness unless the managers were incompetant
      imho.

      JimC

    • "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)"

      Cash has
      face-value intrinsic value. Once it is used, it is no longer
      cash. It becomes something else with different
      financial attributes.

      "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
      that business."

      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
      speculation.

      JimC

    • "Jim, you are probably a lot smarter than I am in
      this instance..."

      I doubt it.


      "...however, as an example, one of the stocks I own is DANB.
      They project store openings, and in fact open stores.
      That is a use for cash. If there are no stores opening
      this quarter yet they are opening next quarter, I
      would rather keep the cash than have to borrow it
      later."

      Depends how they finance store openings. You don't know
      if they'll use next quarter earnings, retained
      earnings, cash in the bank, short-term securities,
      long-term investments or borrow from Japanese banks.


      Opening new stores should increase a company's return on
      shareholder equity. If it does not, then what's the point? My
      company better increase my returns or I'm
      leaving.

      "This is a (I think) concrete example of a projected
      use for cash, no? Do you think that 90 percent of
      those kinds of projections fail? Why do they bother
      reporting them then? (I do know, from my working
      experience, that any kind of revenue projections are worse
      than worthless)"

      To be brutally honest,
      reporting this information is only for the speculators'
      (sometimes called analysts) benefit to project earnings.
      That's it. Anybody can calculate same-store sales, sales
      per square foot and such simply based on past
      performance. Giving quantifiable numbers such as 5 extra
      stores just gives analysts something to play
      with.

      No significant business transaction aside from those
      required by the SEC will be reported in an annual report.
      Problems may be cited and solutions recommended, but
      that's really the extent of it.

      This goes back to
      investing like you own the business. If you ran a
      restaurant you would never tell your competitor that you're
      going to open up next door, or try and find a supplier
      that will undercut hers. That's giving away your
      competitive advantage.
      Warren Buffett won't tell anybody
      his holdings unless there is a clear advantage for
      Berkshire Hathaway to do so, or until the SEC forces him
      too. In fact, Warren Buffett asked to go outside of
      normal SEC rules. The SEC gave him more time before he
      had to disclose - not less, which is what he
      wanted.

      If management has kept returns on shareholder equity
      high, then whether they open 10 stores or 15 stores is
      splitting hairs. The best you can do with such information
      is find out how much each store contributes to the
      bottom line and see if such decisions are reasonable.
      That is, if they will keep return on equity over 15%.
      Return on equity is everything.

      "The primary test
      of managerial economic performance is the

      achievement of a high earnings rate on equity capital
      employed
      (without undue leverage, accounting
      gimmickry, etc.) and not the
      achievement of consistent
      gains in earnings per share."
      - Warren Buffett, 1979
      Chairman's Letter to Shareholders

      JimC

    • "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
      well.

      JimC
      The Toronto Investment
      Club
      http://torontoinvest.ndsn.com

    • The intrinsic value of cash is its face value. My
      own hypothesis is that the IV of a company changes at
      the moment of investment. That is, the IV of cash
      changes the moment you put it to work. If you put it in a
      bond, you can easily calculate the value it will return
      to you over time. If you put the cash to work in a
      business (i.e. buy shares), you have changed the IV of
      that cash.

      That is why it was not silly to
      value BRK at $19 per share back in 1965 when present
      management took over. If you had a crystal ball, you could
      have paid ten times that price per share back then,
      and you would still have a great rate of return. But
      WEB hadn't yet made all of the great investment
      decisions that he had made, making BRK as valuable as it is
      today.

      Morriss Partee

    • 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.

    • >>Your posts are about the most irritating
      second guessing bullshit ravings on this board. KNOCK IT
      OFF!! <<

      I find BRKrules' posts are
      interesting and raise valid questions. Keep up the good work,
      BRKrules! I have no idea where your hostility is coming
      from, Greg.

      Morriss Partee

    • 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
      over-valued.

      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
      offended.

      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
      well.

    • 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"

      Yeah, yeah...
      just daydreaming... :-o

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