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'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.
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.
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
"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
"Jim, you are probably a lot smarter than I am in
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
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
"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
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
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
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
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
(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
"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
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 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
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
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
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
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