Friday, February 12, 2010

What Is Intrinsic Value? - Buffet’s Filter

In my quest to determine what “intrinsic value” means to me in my own investment decisions it would be strange if I failed to consult the greatest living investor, Warren Buffet. His writings and quoted sayings are ubiquitous; but here are a few that resonate with me.

“… buy stock in businesses that are so wonderful that an idiot can run them; Because sooner or later, one will.”
From a panel discussion in 2008

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
Berkshire-Hathaway 1989 Letter to Shareholders

“Here’s what we’re looking for:
“(1) Large purchases (at least $10 million of after-tax earnings),
“(2) demonstrated consistent earning power (future projections are of little interest to us, nor are “turnaround” situations),
“(3) businesses earning good returns on equity while employing little or no debt,
“(4) management in place (we can’t supply it),
“(5) simple businesses (if there’s lots of technology, we won’t understand it),
“(6) an offering price (we don’t want to waste our time or that of the seller by talking, even preliminarily, about a transaction when the price is unknown).”
Berkshire-Hathaway 1989 Letter to Shareholders

“The key to investing is … determining the competitive advantage of any given company and, above all, the durability of that advantage.”
July 1999 at Herb Allen’s Sun Valley, Idaho Retreat

So, what exactly resonates in these Warren Buffet quotes?

First, I want to own only wonderful businesses. I’ve seen first hand how an idiot at the top can destroy an average business. I’ve also witnessed a good, but not wonderful, business muddle through with an idiot at the top.

Second, don’t pay too much, but its okay to pay a fairly valued price for a wonderful business. Microsoft, Cisco, Amazon, and eBay may be wonderful businesses and fairly priced today, but for the folks who bought them in 2000 it’s been a very long decade

Third, a wonderful business has (a) consistent earning power; (b) good returns on equity; (c) little or no debt; (d) good current management; (e) a business model I understand; and (f) a durable competitive advantage.

That’s a great list. However, every item needs a detailed definition before it becomes actionable. For example; what does “fairly valued” mean? What is consistent earning power? What is a good return on equity? How do you know the current management is good versus just lucky? What is a company’s competitive advantage and what would make it durable?

I’m making progress here. But I’ve still some way to go before I’ll know exactly what intrinsic value means to me

Link to Other Topics in the Special Report: What Is Intrinsic Value?


  1. Good article, Neko.

    One very useful concept I've learned and put to good use when it comes to fundamental investing like you've outlined above is always insisting on a margin of safety.

    You can never exactly calculate the intrinsic value of a company -- it always will be your best estimate.

    But by buying with a margin of safety, you can insulate yourself against some of the downside.

  2. Thanks for your comment. I'll give some thought to the margin of safety; specifically its definition and how big is big enough.