Key to Warren Buffett’s efforts to find a company worth buying, whether it is the whole company, or just a minority stake, is his determination of the company’s intrinsic value. For Buffett, that intrinsic value is all about the future cash flow of the business. In his mind, those cash flows are like the interest paid on a bond, but unlike with bonds, the interest rate is not printed on a share of stock as it is with a bond.
“If we could see in looking at any business what its future cash inflows or outflows from the business to the owners, or from the owners, would be over the next, we’ll call it a hundred years, or until the business is extinct, and then could discount that back at the appropriate interest rate, which I’ll get to in a second, that would give us a number for intrinsic value,” Warren Buffett said at the 1997 Berkshire Hathaway Annual Meeting. “In other words, it would be like looking at a bond that had a whole bunch of coupons on it that was due in a hundred years. And if you could see what those coupons are, you can figure the value of that bond compared to government bonds, if you want to stick an appropriate risk rate in. Or, you can compare one government bond with 5 percent coupons to another government bond with 7 percent coupons. Each one of those bonds has a different value because they have different coupons printed on them. Businesses have coupons that are going to develop in the future too. The only problem is they aren’t printed on the instrument, and it’s up to the investor to try to estimate what those coupons are going to be over time.”
Buffett’s full explanation on determining intrinsic value
© 2021 David Mazor
Disclosure: David Mazor is a freelance writer focusing on Berkshire Hathaway. The author is long in Berkshire Hathaway, and this article is not a recommendation on whether to buy or sell the stock. The information contained in this article should not be construed as personalized or individualized investment advice. Past performance is no guarantee of future results.