**Rare Gem** Warren Buffett & Charlie Munger on Intrinsic Value and Business Valuation?

and this is a question about intrinsic value and it's a question for both of you because you have written that perhaps you would come up with different answers you write and speak a great deal about intrinsic value and you indicate that you try to give shareholders the tools in the annual report so they can come to their own determination what I'd like you to do is expand upon that a little bit first of all what what do you believe to be the important tools either in the berkshire annual report or other annual reports that you review in determining intrinsic value secondly what rules or principles or standards do you use in applying those tools and lastly how does that process that is the use of the tools the application of the standards relate to what you have previously described as the filters you use in determining your evaluation of a company if we could see in it looking at any business what its future cash inflows or outflows from the business to the owners or from the owners would be over the next we'll call it a hundred years or until the business is extinct and then could discount that back at the appropriate interest rate well which I'll get to in a second that would give us a number for intrinsic value in other words it would be like looking at a bond that had a whole bunch of coupons on it that was doing a hundred years and if you could see what those coupons are you configure the value of that bond compared to government bonds if you want to stick an appropriate risk rate in or you can compare one government bond with five percent coupon to another government bond was 7% coupons each one of those bonds has a different value because they have different coupons printed on them businesses have coupons that are going to develop in the future - the only problem is they aren't printed on the instrument and it's up to the investor to try to estimate what those coupons are going to be over time as we have said in high-tech businesses or something like that we don't have the faintest idea what the coupons are going to be when we get into businesses where we think we can understand them reasonably well we are trying to print the coupons that we are trying to figure out what businesses are going to be worth in 10 or 20 years when we bought See's candy in 1972 we had to come to the judgment as to whether we could figure out the competitive forces that would operate the strengths and weaknesses of the company and how that would look over a 10 or 20 or 30 year period and if you attempt to assess intrinsic value it all relates to cash flows the only reason for putting cash into any kind of an investment now is because you expect to take cash out not by selling it to somebody else because that's just a game of who beats who but by in a sense by what the asset itself produces that's true if you're buying a farm it's true if you're buying an apartment house it's true if you're buying a business and the filters you describe where there are there number of filters which say to us we don't know what that business is gonna be worth in in 10 or 20 years and we can't even make an educated yes obviously we don't think we know to three decimal places or two decimal places or anything what like that what precisely what's going to be produced but we have a high degree of confidence that we're in the ballpark with certain kinds of businesses the filters are designed to make sure we're in those kinds of businesses we basically use long term risk free that's government bond type interest rates to think back in terms of what we should discount at you know that's that's what the game of investment is all about investment is putting out money to get more money back later later on from the asset and and not by selling it to somebody else but by what the asset itself will produce if you're an investor you're looking at what they ask that you're looking what the asset is going to do in our case businesses if you're a speculator you're primarily focusing on what the price of the object is going to do independent of the business and that's not our game so we figure if we're right about the business we're gonna make we're gonna make a lot of money and if we're wrong about the business we don't have any hopes we don't expect to make money and and in looking at Berkshire we try to tell you as much as possible as we can about our business of the key factors those are the things that Charlie on what the things we put in our report about those businesses are the things that we look at ourselves so if Charlie had nothing to do with Berkshire but he looked at our report he would probably in my view he would come to pretty much the same idea of intrinsic value that he would come to from being around it you know for X number of years the information should be there we give you the information that if the positions were reversed we would want to get from you and in companies like coca-cola or Gillette or Disney or those kind of businesses you will see the information and the reports you have to have some understanding of what they're doing but you have that in your everyday activities you'll get that you'll get that kind of knowledge and you won't get it you know in terms of some high tech company but you'll get it with those kind of companies and then you sit down and you you try to print out the future Charlie I would argue that one filter that's useful in investing is the simple idea of opportunity cost if you have one opportunity that you already have available in large quantity and you like it better than 98% of the other things you see way you can just screen out the other 98% because you already know something better so that people who have a lot of opportunities tend to make better investments then people that don't have a lot of opportunities in and people will have very good opportunities and using a concept of opportunity costs they can make better decisions about what to buy with this attitude you get a concentrated portfolio which we don't mind that practice of ours which is so simple it's not widely copied I do not know why now it's copied among the Berkshire shareholders I mean all you people have learned it but it's not the standard in investment management even at great universities and other intellectual institutions you hear a interesting question if we're right why are so many eminent places so wrong several possible answers to that question yeah the the attitude though I mean if somebody shows us a business the first thing goes through our head is would we rather own this business and more coca-cola would we rather on it than more Gillette we it's it's crazy not to compare it to things that you're very certain of there's very few businesses that will find that we're a certain of the future about as as company such as that and therefore we will we will want companies where the certainty gets close to that and then we'll want to figure that we're better off than just buying more of those if every management before they bought a business and some unrelated field that they might not have even heard of you know more than a short time before that being promoted to them but they said is this better than buying in our own stock you know is this better than even buying you know buying coca-cola stock or something that there'd be a lot fewer deals done but but they don't they tend not to measure we try to measure against what we regard as as close to perfection as we can get Charlie well I will say this that the concept of intrinsic value used to be a lot easier because there were all kinds of stocks that were selling for 50 percent or less of the amount of which you could have easily liquidated the whole corporation if you own the whole corporation indeed in the history of berkshire hathaway we've bought things at 20 percent of a been liquidating value and in the old days the Ben Graham followers could run their geiger counters over corporate America and they could spill out a few things and you could easily sit and see if you were at all familiar with the market prices of whole corporations that you were buying at a huge discount well no matter how bad the managed fund that you're buying at 50 percent of asset value or 30 percent or so on done you have a lot going for you and as the world is wised up and as stocks have behaved so well for people that sucks generally have gone to higher and higher prices that game gets much harder now to find something at a discount from intrinsic value those simple systems ordinarily don't work you've got to get into Warren's kind of thinking and that is a lot harder I think you can predict the future in a few places best if you understand a few basic ideas that come from a good general education that's what I was talking about in that talk I gave at the USC business school in other words coca-cola is a simple company if it's stripped down and analyzed in terms of some elemental forces when Charlie's hard to understand Costco either you know I mean there's certain fundamental models out there that do not take you don't have the kind of ability that quantum mechanics requires you just have to know a few simple things but and really know them Charlie talks about liquid email you know talk about closing up the enterprise but he talked about what somebody else would pay for that stream of cash to I mean you could have looked at a collection of television stations owned by a cap cities for example in them in the early-to-mid well in 1974 and it would have been worth we'll say four times what the company was selling for not because you'd close the stations but just their stream of income was worth that to somebody else is just that the marketplace was very distressed depressed although like I say on a negotiated basis you were gone and sold the properties for four times what they the company was selling for and you got wonderful management and I mean those things happen in markets they will happen again but part of part of investing in calculating intrinsic values is if you get the wrong answer when you get through in other words if it says don't buy you can't buy just because somebody else thinks it's gonna go up or because your friends have made a lot of easy money lately or anything of the sort you just you have to be able to to walk away from anything that doesn't work and and very few things work these days you also have to work walk away from anything you don't understand which in my case is a began to captain but you would agree with Joran that it's much harder now yeah but I would also agree that almost at any time over the last 40 years that we've been up on a podium we would have said it was much harder in the past but it is harder now it's way harder at the part of part of it being harder now too is the amount of capital we run I mean if if we were running a hundred thousand dollars our prospects for returns would be and and we really needed the money our prospects for return would be considerably better than they are running Berkshire it's just it's very simple our universe of possible ideas would expand by a huge factor we are looking at things today that by their nature a lot of people have to are looking at and there were times in the past when we were looking at things that very few people were looking at but there were other times in the past when we were looking at things where the whole world was just looking at them kind of crazy and and that that's a decided help so

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Length: 12min 56sec (776 seconds)

Published: Sat Apr 06 2019