a) From Warren Buffett’s perspective, what is the intrinsic value?
Intrinsic value is succinctly summed up by Warren Buffett as “the present value of future expected performance” (Bruner, Eades, & Schill, 2009). This intrinsic value can encapsulate how well the company is run, its cash flow and places a premium on management competency.
Why is it accorded such importance?
Intrinsic value is considered important in value investing as it allows Buffett to identify stocks or businesses which are undervalued. This is important as “intrinsic value is the value of a company's business, not its stock” (Carbonara, 1999).
How is it estimated?
Buffett readily admits that intrinsic value is highly subjective (Bruner et al., 2009). Buffett’s method is to estimate ‘discounted cash flows’ (Carbonara, 1999). This is similar to the NVP, of a business cash flow, discounted to today’s value to obtain an estimated intrinsic value. Though it is an estimate, this does not bother Buffett as he stated that “it is better to be approximately right than precisely wrong” (Bruner et al., 2009).
What are the alternatives to intrinsic value?
An alternative to intrinsic value is book value or accounting profit. That is instead of investing based on the company book value or accounting statements instead.
Why does Buffett reject them?
Buffett rejects these alternatives as he emphasizes “economic reality, not accounting reality” (Bruner et al., 2009). Book value is useless as a determinant of intrinsic value as it does not fully reflect the relationship between rates of return and the required rate of return. Typically book value is considered to be historical input whereas intrinsic value is the measure of future output (Bruner et al., 2009).
b) Critically assess Buffett’s investment philosophy. Be prepared to identify points where you agree and disagree with him.
Buffett’s mantra is that “It’s far better to buy a wonderful company at a fair price than a fair