We talk about intrinsic value here from time to time. In order to define intrinsic value, we need to explain what it is not.
It is not the stock price. Although most of the time the stock price of any given security is very close to intrinsic value. This is because markets tend to be very efficient. When stocks become underpriced, they tend to be bought by well-informed investors, which drives up the price until any discount has disappeared.
Benjamin Graham, author of the Intelligent Investor and Security Analysis, I believe first defined the idea of intrinsic value in his early writings. Graham said intrinsic value “was the fundamental, objective value of a stock based on its cash flows, dividends, assets, and growth rates.”
He went on to state various formulas to correctly compute intrinsic value for a company. I would add that intrinsic value could also be the net asset value of an enterprise. For instance, a company could own very valuable real estate. If the real estate has been owned for some time it might be worth considerably more than the value that is carried on the financial statements (balance sheet). An investor would in that case make an adjustment to come up with the net asset value of the company.
Intrinsic value calculations can vary depending on what industry you are trying to assess. For example, valuing Berkshire Hathaway, (which Warren Buffett has already told us how to do) is very different from valuing a bank or a technology company.
Some academics dismiss the idea of intrinsic value being markedly different than the stock price. But this has been resoundingly disproven. We can use a very recent example to prove our thesis.
In 2022 Meta or Facebook traded in a range from $400 before falling to less than $100. Is Meta worth $100 or $400 or somewhere in between? Also consider its stock price fluctuated between these two numbers in a period of a few months. Did the value of the company change that much in such a short period of time? Or was the market making a mistake?
As an investor I really wanted to know what was the sustainable operating income of the company. Meta was spending inordinate amounts of capital on the Metaverse at the time. This enormous spending was masking the profitability of the core business, which is its social media apps, (Facebook, Instagram, Messenger).
We did our own work and determined that Meta stock’s intrinsic value based on its sustainable operating earnings was around $300 a share. But with the stock trading at $100 a share we really didn’t have to be precise in our calculations. In fact we determined that if Meta’s apps experienced zero growth for the next 10 years that the stock was worth around $120 a share, 20% more than the current price. We felt there was a huge margin of safety.
Meta wasn’t hiding from the market, in fact it’s one of the highest profile stocks in the world. The market gave us this opportunity because everyone hated the stock and how they were allocating their capital. Around this same time NYU professor Aswath Dasmoradan published his own appraisal of Meta. Dasmoradan is highly respected for his valuation work and often publicly posts about stocks he has assessed. His conclusion mirrored our own, citing the downside as being pretty much zero. But even after that the market did not reassess Meta’s valuation until several weeks after that posted report. It took Meta CEO Mark Zuckerberg to announce that he was halting spending on the Metaverse and earnings catapulted upward. Today it trades around $500 a share.
While all this was going on do you think that the real “intrinsic” value fluctuated that much? No, probably not, by our assessment Meta was worth $350-400 a share. A pretty wide range, but the margin of safety was so huge, we didn’t have to be precise.
We’ve been calculating Berkshire Hathaway intrinsic value for over 20 years now. Berkshire is structured quite differently than Meta. They own over 90 individual companies and have a large investment portfolio. In Berkshire’s case we take the operating earnings for the trailing 12 months and apply a multiple to those earnings. This gives us a fair market value for those assets. Then we take the fair market value of the investment portfolio and add those two together. We make several adjustments for fluctuations in the insurance business and add excess cash and subtract all the debt. Today this value is around $450-460 per B share. Not much over today’s stock price of $445.
We’re not buying Berkshire today because that discount is not wide enough. But in the recent past it has been as much as 20%. To buy such a quality company at a 20% discount to conservative “intrinsic value,” makes us quite content. We’re very happy to own a stock of such high quality especially while its compounding by 7-9% per year.
Look at your favorite stocks. Is there a wide differential between the 52-week highs and lows? Does this mean intrinsic value changes that much during the year. No, it probably changes very little if at all. Mr. Market is erratic. He values stocks higher when he is optimistic and lower when he is depressed.
We believe understanding intrinsic value is a key to successful long-term investing. What you pay for an investment determines your rate of return. If you are patient and don’t pay too much a great deal of your work is done. It takes discipline not to pay too much for a stock you like. If I can calculate a reasonable intrinsic value, it makes that task much easier.
As always if you have any questions about this or anything else investment related please feel free to reach out to us at CSH Investment Management. We’d love to talk with you.
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Or visit our website at www.cshinvestments.com
Thank you
C Steve Henry