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INTRINSIC VALUE RISK
Intrinsic
value investors reject the notion that volatility is a useful measure of the risk of
owning a company. Since the intrinsic value depends on estimates of value drivers
many years into the future, about which information unfolds only slowly, intrinsic value
estimates, in the absence of major events, change only slowly. Market prices,
in contrast, can be very volatile. But intrinsic value investors like market
price volatility, since it gives them more opportunities to buy or sell at prices far
different from intrinsic value. Without volatility there would be no
over-valued or under-valued companies and the intrinsic value investor would not be able
to earn above-average returns. The intrinsic value investor knows there are two
different types of risk. The first, the risk that the market won't pay you a fair
price for your company when you decide to sell it, is a temporary risk.
Our research shows that, although market prices can drift away from intrinsic value for
considerable lengths of time, they tend to converge on intrinsic value with a two or three
year horizon. For a long-term investor with flexibility in the timing of
selling investments, this market risk is not a major concern. The second type of
risk, intrinsic value risk, is the likelihood that the market will pay you a fair price
for your investment, but you won't like it. That is, the company's intrinsic value
has deteriorated while you own it. This risk, that the company's value drivers,
hence intrinsic value, are significantly worse than your original projections is the
principal source of risk to a long-term investor.
INTRINSIC VALUE
INVESTING
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