WHAT IS INTRINSIC VALUE? Why Is It Important?
As many people in my network already know, Warren Buffett is one of my favorite people. I have read nearly every piece of literature on the man, and hope to one day spend a few minutes picking his brain.
One thing Warren frequently references regarding investing, is Intrinsic Value. As I read the recent Berkshire Hathaway Annual Stakeholder letter, I thought this is something that I would shed some light on how it affects my life.
INTRINSIC VALUE: 1. FIRST LET’S DISCUSS THE DEFINITION OF INTRINSIC VALUE
“The intrinsic value is the actual value of a company or an asset based on an underlying perception of its true value including all aspects of the business, in terms of both tangible and intangible factors.” (Investopedia)
When thinking about Intrinsic Value, we consider the Tangible and Intangible factors that determine the worth of a company, and in my life how I value people. Even in Berkshire’s Latest Stakeholder letter, Warren discusses the fact that Intrinsic Value is a number that is hard to measure precisely.
“As much as Charlie and I talk about intrinsic business value, we cannot tell you precisely what that number is for Berkshire shares (nor, in fact, for any other stock). It is possible, however, to make a sensible estimate.”
The hard math used in calculating the objective factors is much easier to determine than an intangible factor.
INRINSIC VALUE: 2. WHAT ARE THE TANGIBLE FACTORS OF A BUSINESS?
- Buildings and Land
The value behind the hard product and or service is the first place to start. How does a business impact the lives of the people it serves?
I also wonder what is the price of this product and or service and how does that relate the profitability of a business. Especially based on how many sales we can generate, and how it relates to benefits received by the customer.
After I have established these fundamentals, I wonder what machines and infrastructure we will need to create our product, deliver the service, and where we will need to set up our headquarters/warehousing.
Next, we evaluate how much cash we have to float the operations and marketing of the business over the next few business cycles. Do we need to seek outside investment?
Last I like to evaluate how much debt will need to be taken on and how much equity is held in a company? Do we own any real estate? Are the products and services owned or contracted out through 3rd party suppliers?
Once we have information on all of these tangible factors, we can do some math to decide whether or not we are getting involved in a viable business idea. At least from a quantitative perspective.
INTRINSIC VALUE: 3. WHAT ARE THE INTANGIBLE FACTORS OF A BUSINESS?
- Networks & Relationships
- Brand Reputation
- Software Capabilities
- Trade Secrets
Networks & Relationships are assets that businesses can leverage to create more work for the company. This depends on the demand for the product our service your business can deliver to these people or their network. One of the best forms of marketing is word of mouth.
Brand Reputation is one of the most important factors to consider especially in how it relates to your network and your relationships. Your business is more likely going to generate more referrals if you are providing a quality product/service and excellent customer experience.
Software Capabilities are a significant benefit when scaling a business or trying to create a proprietary solution for customers. If your company has a system in place that can quickly scale up to a million plus customers, without too much investment in the infrastructure needed to manage the relationship. You are one step ahead of those who have antiquated systems that can’t support that kind of growth.
Trade Secrets are essential and not very accessible. Such as the spices in KFC’s chicken recipe, or a High-Frequency Trading firms algorithms for executing trades. These pieces of information can be a business’s competitive advantage and provide the right edge to be successful.
INTRINSIC VALUE: 4. WHAT ARE THE TANGIBLE FACTORS IN PEOPLE?
People have tangible assets. Like the education, they have received, and the skills they have developed, and their past accomplishments. It is difficult to evaluate the value someone can bring to the table unless we give credit and weight to these different areas.
For instance, someone who has recently graduated from a respectable college with a BComm degree has the education. What if they haven’t done anything in life or developed too many hard skills? What if they dropped out and built Facebook? Depending on where they received their degree you can credit a certain amount of weight to the knowledge they have obtained.
More often than not as we grow older this weight shifts to the things we have accomplished, which likely means we can tap into these prior accomplishments and reproduce similar results and perhaps build on our achievements.
If you can put these two forces together, you may have something extremely valuable.
INTRINSIC VALUE: 5.WHAT ARE THE INTANGIBLE FACTORS IN PEOPLE?
- Work Ethic
These two assets in people will determine what they can accomplish in their life. If someone is capable of putting in the hard work necessary to be successful, while maintaining a positive attitude when obstacles and disappointment are present, they will create their own success.
You should always seek to find these and bring them on your team. They are the ones who focus on finding solutions to problems and will take the action necessary to reach goals.
INTRINSIC VALUE: 6. WHAT DOES THIS ALL MEAN?
In the end, life moves pretty fast and we don’t always have all the time we would like to evaluate the decisions we make. If you can learn to see through the fluff that modern marketing and sales tactics people throw at you.
By using an intrinsic value approach to investing (in businesses and people), you will see tremendous success in your life; whatever success means to you. Some people want the freedom to choose where they apply their time, and others are interested in accumulating vast amounts of wealth.