Essay About Value Creation And Intrinsic Value

Warren Buffet Case Solutions
In 1977, the firm’s year end closing share price was $102; on May 24, 2005, the closing price on its Class A shares reached $85,500. Over the same period, the Standard & Poor’s 500 Index grew from 96 to 1,194. Began in textile; BHI utilized the textile as a cash cow to put money into acquisitions and made the first purchase into insurance companies headquartered in Omaha: National Indemnity Company and National Fire & Marine Insurance Company. BHI exited the textile business in 1985.[pic 1]The 8 Buffett’s investment philosophies that the author identifies are:Economic reality, not accounting reality“Ignore… consolidated numbers… accounting consequences do not influence our operating or capital-allocation process.”Investment should be based on “economic reality,” intangible assets, such as patents, trademarks, special managerial expertise, and reputation might be very valuable where GAAP would carry no value.GAAP measured results in terms of net profitEconomic reality, the results of a business were its flows of cashThe cost of the lost opportunityFrame choices as yes/no decisionsThere was no fundamental difference between buying a business outright and buying a few shares of that business in the equity marketThe comparison of an investment against other returns available in the market was an important benchmark of performance.Investment opportunity against the next best alternative, the “lost opportunity”Value creation: Time is moneyMeasured intrinsic value as the present value of future expected performanceThe intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors. This value may or may not be the same as the current market value. [pic 2][pic 3]The relationship between the expected returns and the discount rate: in the first case, the spread is positive; in the second case, it’s negativeWhere expected returns equal the discount rate will book value equal intrinsic valueBook value or the investment outlay may not reflect the economic realityMeasure performance by gain in intrinsic value, not accounting profit. Measure by per-share progressRate of per share progress – usually diminish in the future – must exceed that of the AVERAGE large American corporationRisk and discount ratesBuffett contrarian thinking use the rate of return on the long-term (for e.g., 30 year) US Treasury bond to discount CF as opposed of CAPMHis firm used almost no debt financing and focus on companies with predictable and stable earnings.“Risk comes from not knowing what you’re doing.”DiversificationContrarian view that investors should hold a broad portfolio of stocks to hedge risks – purchased too many rather than waiting for the right oneFigure businesses out that you understand and concentrateDiversification is protection against ignoranceInvesting behavior should be driven by information, analysis, and self-discipline, not by emotion or “hunch”Over long term, stock prices should have a strong relationship with the economic progress of the business. But daily market quotations were heavily influenced by momentary greed or fear, and were an unreliable measure of intrinsic value.Contrarian – “we simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”Alignment of agents and owners“We will only do with your money what we would do with our own, weighing fully the values you can obtain by diversifying your own portfolios through direct purchases in the stock market. Buffett assessed intrinsic value as the present value of future expected performance.Defined intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future CFs are revised and as interest rates move. Intrinsic value is all important and is the only logical way to evaluate the relative attractiveness of investments and businesses.Buffett scorned the academic theory of capital market efficiency. To what extent does Buffett’s method differ from typical calculations of economic value added and market value added?Accounting reality vs. Economic realityEconomic reality > intangible assets > can be very valuableAccounting reality > intangible assets > little or no valueWhen we invest in stocks, we invest in businesses – Over long term, stock prices should have a strong relationship with the economic progress of the business. But daily market quotations were heavily influenced by momentary greed or fear, and were an unreliable measure of intrinsic value.These items are: patents, trademarks, special managerial expertise and reputation. Under GAAP, they would be carried at little or no value. GAAP measured results in terms of net profit; in economic reality, the results of a business were its flows of cash.Not neededNeed Help______