Sunday, 26 February 2012
INTRINSIC VALUE: THE RIGHT PRICE TO PAY
Both Warren Buffett and Benjamin Graham talk about the intrinsic value of a business, or a share in it. That is, to buy a business, or a share in it, at a fair price.
But, having regard to the possibility of error in calculating intrinsic value, the careful of investor should provide a margin of error by only buying the business, or shares, at a substantial discount to the intrinsic value.
Buffett is said to look for a 25 per cent discount, but who really knows?
Buffett’s concept, in looking at intrinsic value, is that it values what can be taken out of the business.
He has quoted investment guru John Burr Williams who defined value like this:
‘The value of any stock, bond or business today is determined by the cash inflows and outflows – discounted at an appropriate interest rate – that can be expected to occur during the remaining life of the asset.’ – The Theory of Investment Value.
The difference for Buffett in calculating the value of bonds and shares is that the investor knows the eventual price of the bond when it matures but has to guess the price of the share at some future date.