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How To Calculate Intrinsic Value like Warren Buffett in 30 Minutes
A simple approach to calculating the intrinsic value for the everyday investor
It probably took me a good year until I understand Warren Buffett’s methodology of calculating intrinsic value.
The reason is that it’s such a vague topic.
This is what the sage has to say about intrinsic value:
Intrinsic value is an all-important concept that offers the only logical approach to evaluating the relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is the discounted value of the cash that can be taken out of a business during its remaining life.
Unless you're a finance major, this probably doesn’t make sense to you.
To be frank, it doesn’t make too much sense to me either, but I did find a good book called The Warren Buffett Way by Robert G. Hagstrom which at least explained the step-by-step guide to calculating intrinsic value.
Calculate Owners’ Earnings
Warren likes this value called Owners’ Earnings. It’s basically how much the owners of the company take home in cash.
This is how Warren Buffett defines its calculation:
If we think through these questions, we can gain some insights about what may be called “owner earnings.” These represent (a) reported earnings plus (b) depreciation, depletion, amortization, and certain other non-cash charges such as Company N’s items (1) and (4) less the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume.
That’s way too complicated for me.
I prefer this calculation, which I picked up from The Warren Buffett Way:
Owners’ Earnings = EBIT or Operating Profit + Depreciation and Amortization — Capital Expenditure.
Let’s see how this looks in practice.
