Wednesday, 5 March 2014

Warren Buffett Intrinsic Value Calculation - A stock must be undervalued

"Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life." - Warren Buffett

"As our definition suggests, intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates mover or forecasts of future cash flows are revised. Two people looking at the same set of facts, will almost inevitably come up with at least slightly different intrinsic value figures." - Warren Buffett

"The cash that can be taken out of a business during its remaining life." - Warren Buffett

"In other words, the percentage change in book value in any given year is likely to be reasonably close to that year's change in intrinsic value." - Warren Buffett

@ 20.15 Finding intrinsic value of Disney (using MSN Money) calculator


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Tong Leong Lim said...

Thanks for sharing.

If we want to calculate Malaysia stock Intrinsic value, can we using 10 year Federal Note as well? or we should use the rate that come from Malaysia?

investbullbear said...

Tong Leong Lim

Your question is, which discount rate should you use?

Allow me to answer this in a long winded way.

1. Buffett advises staying with high quality companies with predictable Free Cash Flows (FCF).
2. He then uses the 10 year US Treasury Bond rate to discount these FCF to derive his intrinsic value.
3. He buys with a discount (his margin of safety).

We are in a low interest rate environment at present. Your Malaysian FD gives an interest rate of about 4%. Your ASB gives returns of around 6%.

Assuming you have a company with predictable FCFs, you can choose to discount these FCFs with your risk free FD rate of 4% today. This will give you your intrinsic value.

As a prudent investor, you will only buy with a margin of safety.

Valuation is both an art and a science. You aim to be approximately right and not be absolutely wrong. You err on the side of safety of your capital. By protecting your downsides (staying with high quality companies with durable competitive advantage, estimating intrinsic value using conservative assumptions and not overpaying to own them), your upsides take care of themselves.