Buy Good Value and/or What Other People will Like?

[DesertCat]

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Okay, I guess we have different definitions of "intrinsic value"?

Intrinsic value, as I'm using the term, is the present value of future cash flows.

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We have the same definition. The "present value" of future cash flows isn't changing, i.e "present value 2005". But next years value is higher, i.e. "present value 2006". The company will (typically) grow in intrinsic value each year, but it's value discounted back to 2005 stays the same if your projections matched reality.

You discount cash flows for one main reason, the time value of waiting to recieve them. As you go one year into the future, you have to wait one less year for those earnings, and you have one more year of earnings reinvested in the business or dividended to you.

Example, pretend there is a company called "CashCo". It's going to be in a risk free business for five years, make $1 per share per year, and dividend the total ($5) all to the shareholders on Dec. 25, 2010. You run a dcf on it, and come up with a value around $4 today. Shares are trading at $4.25, so you decide IV is less than price, and so don't buy.

But five years from now, on December 1, 2005, you run into a shareholder of CashCo who's frantic. He's getting a $5 payout in 25 days, but needs to buy Xmas presents now. He offers his CashCo share to you for $4.50. Do you say, well I estimated the IV of CashCo and it's only $4? No, that was five years ago. The present day value of cashco is very close to $5 per share, so I hope you take advantage and buy as many shares as possible, that's 10%+ gain in only 25 days.

Redo your monsanto analysis with 2006 as the date of purchase. Starting revenues are higher, earning are higher. Why wouldn't you be willing to pay a higher price for Monsanto in 2006 than you would in 2005? Or in 2009, you are walking down the street and a guy hisses from an alley, "hey, got some monsanto for you". Now sales have doubled, earnings are up 250%. It's not worth more to you?

Growing companies increase their cash flow, and hence, IV each year. As a shareholder you benefit from that. It helps compensate you when a "value gap" doesn't close.

[Evan]

DesertCat,

Your example of an investment where all the cashflows come in one year is a very specific one and my first instinct, without working it out, is that it leads to a different conclusion than real life. If instead of all the cashflow coming in year 5, it instead came every year but lets say investors could only invest for 5 years at a time, then its worth the same at any point. Even if you extend the life of the business into perpetuity, if we're still assuming constant cash flows of 1 every year, it's worth the same whenever you buy it.

When you start adding growth and adjusting for real instead of nominal dollars you may be right, but I don't think your example shows it very clearly. I'll definitely think about it.

[edtost]

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DesertCat,

Your example of an investment where all the cashflows come in one year is a very specific one and my first instinct, without working it out, is that it leads to a different conclusion than real life. If instead of all the cashflow coming in year 5, it instead came every year but lets say investors could only invest for 5 years at a time, then its worth the same at any point. Even if you extend the life of the business into perpetuity, if we're still assuming constant cash flows of 1 every year, it's worth the same whenever you buy it.

When you start adding growth and adjusting for real instead of nominal dollars you may be right, but I don't think your example shows it very clearly. I'll definitely think about it.

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his position holds whenever growth > r.