Intrinsic Value Investment Philosophy
Value: Using the "value" technique in the investment world usually means
buying stocks with low Price/Earnings Ratios or low Price/Book Value Ratios. But
"value" in this sense is unrelated to the ability of any company to build wealth
for its shareholders. In fact, just the reverse. "Value" companies nearly always
have low profit, low growth, or worried investors.
Growth: Using the "growth" method of investing usually means buying
stocks of companies whose sales and earnings are increasing rapidly and whose business is
"successful". But these companies often sport very high Price/Earnings Ratios
and high Price/Book Value ratios. But, "growth" in this sense can be unrelated
to future changes in stock price. Too much enthusiasm gets poor investment returns.
Intrinsic Value: Using the Intrinsic Value method overcomes the main flaws of
both "value" and "growth" investing. By estimating the future cash
flows for any new stock investment and discounting those cash flows to the present with a
reasonable discount rate, an investor can estimate the true worth, what we call the
Intrinsic Value, in stock price terms. This approach works as well for Chrysler as it does
for Coca Cola, as well for Westinghouse as for Walt Disney.
The focus of Intrinsic Value investing is necessarily long-term. We have
designed and built a quantitative tool for calculating intrinsic value. The forecast
period covers as much as thirty years in the future and a perpetual period thereafter. The
forecasts used are both for the income statement and the balance sheet. Integrating these
financial statements enables an investor to assess both business plans and the financial
capability for carrying out those plans. Other investment methods do not integrate these
financial statements. Intrinsic Value investing looks at a company as a business in total.
The cash flows which are discounted are operating cash flows, before any payments to
bondholders or stockholders. The stockholders' portion of the present value of the total
business is found by simply subtracting the current market value of all interest-bearing
obligations. The Intrinsic Value price is the stockholders' portion divided by the shares
Using a discount rate which is tied to "macro" fundamentals: inflation, tax
rates and real interest rates, gives a manager an alternative to trying to interpret
economists' forecasts in equity decision-making. Changes in Fed policy, capital gains
taxes, income tax rates and other fiscal and trade policy changes can be explicitly
incorporated into the discount rate used in Intrinsic Value investing. Other approaches do
not offer such a direct link from the external environment into the pricing of stocks. (see Glossary for more detailed definitions.)
Implementing Intrinsic Value Investing: Managing an equity portfolio means
making decisions, buying and selling. Because Intrinsic Value investing gives you a target
value to compare to the market price of a stock, just as in arbitrage, you can buy stocks
below their true worth. Further, with this approach, you can calculate what a stock will
be worth at any date in the future. Together with an estimate of dividends, you can
calculate an expected return from the current price onward. Intrinsic Value methods fit as
well in a quantitative investment organization as in a purely fundamental group.
Why Intrinsic Value Investing?
A disciplined set of rules for buying cheap and selling dear gives you an
advantage over any other method. The Intrinsic Value approach outlines for clients what
they should expect from a manager in clear and explicit terms. Having a discipline allows
for consistency of results. Not that every short period will have exactly the same
excellent stock performance, but over time, the link between investment decisions and
investment results should be direct and easily communicated to clients.
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Management, LLC All Rights