Sshh, value doesn’t matter!
Never did, never will. Prudent investors fuss about something other than value.
Here’s an investing secret. I don’t estimate business value. I never have. I never will. It’s not that I can’t, at least in an approximate sense. I don’t even try, as I have no use for it. I’m not saying this because I have succumbed to the ongoing crap-fest. I say this as a proud, continuing value investor.
I deliberately started this essay in a confusing, click-baity way. My aim is to table a crucial clarification, all the more important at a time when dubious large numbers are passed off as estimates of business value. A precise, ambitious estimate of value isn’t merely a wrong answer. It answers a wrong question, one that prudent investors don’t ask at all. To understand this better, let’s start from first principles.
Intelligent investing rests on three tenets.
Intrinsic business value. Margin of safety. Mr Market. If we truly understand the essence of Ben Graham’s three tenets, we’re done. There’s nothing else to sensible investing. View stock as business. Roughly gauge what it’s worth, in the few cases where we can. Since world is all messy and we’re all buggy, don’t cut it too fine. Keep some cushion. View nutty counterparties as entertainment, unless they offer something actionable based on the above. The Master’s 3-part articulation is perfect for understanding investing. However, there’s a small nuance in translating knowledge into practice. This is to recognize that the parts aren’t independent.
Two tenets – intrinsic business value & margin of safety – are inseparable.
Say, you present me with an understandable business. If you’re a masochist, you may have read my 100+ essays to gauge how I’d think about investing in it. If you’re smarter, you’ll plead TLDR and just ask me. Either way, my answer would have no reference to value. It wouldn’t even occur to me to ask the question “What’s the value of this business?”. The actual question that I ask myself is “Around what buy-price am I fairly sure that I’m getting a decent deal?”. The first question focuses exclusively on value. The second, more practical question blends intrinsic business value and margin of safety to help me reach an actionable decision.
Even for predictable businesses, my guesstimate of business value will have wide error-bars. Range may be 100 to 150. I might try to buy at 70 or 80. If I’m feeling lucky or if I succumb to torture of waiting, I’ll push it to 90. Whatever be that number, I never do an artificial separation of value and safety-margin. I don’t think of it as value 120, safety factor 33%, buy-price 80. At the extreme, whether it’s 120 or 150 is irrelevant. All that matters is that I am at peace buying at 80. As I reflect on my last fifteen years, I haven’t spent any time on whether fair value is 28x earnings or 45x earnings for any business. It’s entirely been about whether my walk-away price, an implicit amalgam of value and safety, is 18x or 22x. I have vague conviction that intrinsic business value is well above my walk-away price given all that I understand about risk and quality.
It is my biased impression that many investors think this way, including the ones on investing’s Mount Rushmore. Margin of safety is so ingrained into their thinking about what’s a safe buy-price that they don’t particularly fuss about calculating intrinsic business value as a standalone figure. Buffett has never mentioned what Berkshire’s fair value is, but buyback makes clear what price Buffett is comfortable buying Berkshire. Value doesn’t matter, so long as it’s comfortably above buy-price.
This is why simple works better than sophisticated
In any real-world, reliable sense, DCF is nonsense. It is a sophisticated tool for impostors to delude themselves and others. We suck at forecasting and have no way to reduce risk to a number. Mechanically combining two things we’re bad at, with suspect motives and fairytale assumptions, results in bad-squared, not good. It’s why Munger is on record that he’s never seen Buffett do a DCF. I’d wager that neither of them wastes time on precise forecasts, cost of capital tables or XL, despite (or perhaps due to) their prodigious minds.
A mental model that integrates margin of safety and intrinsic business value acknowledges how unknowable our messy world is. It nudges minds and methods to focus on being roughly right, not precisely wrong. It is why the best investors spend a lot of time ensuring that businesses are predictable, and little time making actual predictions let alone discounting them. With businesses where cashflows and risks are relatively knowable, simple valuation methods suffice. They’re more reliable than seemingly sophisticated models. They result in a buy-price with built-in safety rather than business value estimates with built-in decimal-points.
Ongoing charade is even more flawed than it seems
Greed for commissions and envy over relative performance ensure that any market frenzy is accompanied by dubious rationalization of indefensible valuations. And this is perfectly fine since it’s neither new nor illegal. Most recognize the charade for what it is, even those who choose to participate in it. It’s not hard to realize that numbers thrown around using ever more powerful time-telescopes have nothing to do with intrinsic business value.
My aim isn’t to repeat this obvious realization. It is to point out a deeper flaw with such computations. It’s not just a wrong answer, it’s an answer to a wrong question. At all times, prudent investors don’t fuss about intrinsic business value, apart from being cognizant of a broad range that’s reasonable for a particular business. Trying to pin it down isn’t particularly helpful, except for commentators who aren’t playing the game. What’s helpful to practitioners is a buy-price that offers reasonable certainty of getting more than what we pay for. This goal isn’t achieved through precisely determining value. It’s achieved through a mindset that views value and safety in unison, without even knowing where one ends and the other begins. Without such a mindset, investors get habituated to methods that yield neither value nor safety.