Intrinsic Value

A company’s intrinsic value measures the overall vitality of the business. The calculation of intrinsic value is the single most difficult part of the value investment process.

There are many ways of attempting to value a company. The “discounted cash flow” method, which is the most commonly used, involves estimating the present value of a company’s predicted future earnings. But, given that it is incredibly difficult to accurately predict the future and that even a small error in prediction can result in a huge difference in the calculated value, using this method can easily lead to poor investment decisions.

We take a very different approach. Dismissing future values as too uncertain to predict, we ask, “What is the value of the assets and earnings of the company today?” This form of valuation is more grounded, as it focuses on today’s situation, rather than on what the future might bring. It is also a more conservative approach, often yielding a considerably lower valuation than other methods.

We conduct extensive research to establish the intrinsic value for each company under consideration for inclusion into our portfolio. We consider all aspects of a company’s situation, including its profitability, its sustainability, the level of competition in its market(s), its historical performance and above all, the value of the assets (such as cash, land and property) that it owns.

The aim is to identify and invest in companies that are trading at substantial discounts to their intrinsic values (i.e. they are substantially undervalued by the stock market).

But even this more grounded approach to valuation involves as much art as science, for the concept of intrinsic value incorporates a number of factors for which it is not possible to establish a numerical value. Therefore, in order to manage this uncertainty so as to minimise the likelihood of error and minimise the possibility of loss, the value investor seeks to invest only in those companies that allow for the greatest margins of safety.