Buffett Beyond Value: Why Warren Buffett Looks to Growth and Management When Investing

Chapter 5. Intrinsic Value

In general terms, it [intrinsic value] is understood to be that value which is justified by the facts, e.g., the assets, earnings, dividends, definite prospects, as distinct, let us say, from market quotations established by artificial manipulations or distorted by psychological excesses.^[67]

—Benjamin Graham and David Dodd

Before you risk your hard-earned money on a stock, you probably want to know the value you can expect to get in return. The value you assign to a stock, or that stock's intrinsic value, is the maximum amount that you are willing to pay now for future benefits, which could come from dividends or the potential sale of the stock at a realistic future price. It makes no sense to buy a stock when its intrinsic value is smaller than the current price. Buffett cautions: "The calculation of intrinsic value, though, is not so simple ... intrinsic value is an estimate rather than a precise figure."^[68] In this chapter, I compute the intrinsic value of Wesco Financial, Coca-Cola, and Berkshire Hathaway to more thoroughly explain this concept.

Computing Intrinsic Value

Individuals differ from one another in assessing companies' future prospects. They also differ in their risk tolerance. Hence, it should be no great leap to accept that there is no unique intrinsic value that can be assigned to a common stock upon which everyone will agree. In computing intrinsic value, you should start by examining a company's balance sheet. Some assets, such as cash ...