Warren Buffett: “If You Can’t Answer This, Don’t Buy the Stock.” | Terry Leadership Speaker 2001

[Transcript]

AUDIENCE MEMBER: Hello Mr. Buffett, I got two short questions. One, is how do you find intrinsic value in a company?

WARREN BUFFETT: Well, intrinsic value is what—is the number that if you were all knowing about the future and could predict all the cash that a business would give you between now and judgment day, discounted at the proper discount rate, that number is what the intrinsic value of a business is. In other words, the only reason for making an investment and laying out money now is to get more money later on, right? That’s what investing is all about.

Now, when you look at the stock—when you look at the bond—assuming it’s a United States government bond—very easy to tell how much you’re going to get back. It says it right on the bond. It says when you get the interest payments and it says when you get the principal. So, it’s very easy to figure out the value of a bond. It can change tomorrow if interest rates change, but the cash flows are printed on the bond.

The cash flows aren’t printed on a stock certificate. That’s the job of the analyst, is to “print out”—change that stock certificate, which represents an interest in the business, and change that into a bond and say, “This is what I think it’s going to pay out in the future.” When we buy, you know, some new machine for Shaw to make carpet, that’s what we’re thinking about obviously. And you all learn that in business school. But it’s the same thing for a big business.

If you buy Coca-Cola today, the company is selling for about $110–115 billion in the market. The question is, if you had $110–115 billion, you wouldn’t be listening to me, but—I'd be listening to you instead of that. But the question is, would you lay it out today to get what the Coca-Cola Company is going to deliver to you over the next 200–300 years? The discount rate doesn’t make much difference after—as you get further out. And that is a question of how much cash they’re going to give you.

It isn’t a question of, you know, it isn't a question about how many analysts are going to recommend it or what the volume in the stock is or what the chart looks like or anything. It’s a question of how much cash it’s going to give you. That’s the only reason. It’s true if you’re buying a farm. It’s true if you’re buying an apartment house. Any financial asset, put oil in the ground—you’re laying out cash now to get more cash back later on.

The question is how much are you going to get, when are you going to get it, and how sure are you? And when I calculate the intrinsic value of a business when we buy businesses and whether we’re buying all of a business or a little piece of a business, I always think we’re buying the whole business because that’s my approach to it. I look at it and say, “What will come out of this business and when?”

And what you really like, of course, is then to be able to use the money they earn and earn higher returns on it as you go along. I mean, Berkshire has never distributed anything to its shareholders, but its ability to distribute goes up as the value of the businesses we own increases. We can compound it internally. But the real question is, Berkshire is selling for—we’ll say $105 or so billion now, what can we distribute from that hundred—if you’re going to buy the whole company for $105 billion now.

Can we distribute enough cash to you, soon enough, to make it sensible at present interest rates to lay out that cash now. And that’s what it gets down to. And if you can’t answer that question, you can’t buy the stock. You know, you can gamble on the stock if you want to or your neighbors can buy it. But if you don’t answer that question—and I can’t answer that for—for internet companies, for example. There are a lot of companies—there are all kinds of companies that I can’t answer it for. But I just stay away from those.

AUDIENCE MEMBER: So you’ve got formulas involved in finding intrinsic values on certain companies? I mean, you’ve got a mathematical system set up?

WARREN BUFFETT: It’s the discounted present value of future cash, you know.

AUDIENCE MEMBER: Second short question is, Why haven’t you written down your set of formulas or your strategies in written form so that you can share it with everyone else?

WARREN BUFFETT: Well, I think I actually have written about that. If you read the annual reports over the recent years. In fact, in the most recent annual report, I use what I’ve just been talking about, I use the illustration of Aesop. Because here Aesop was in 600 BC—smart man, wasn’t smart enough to know it was 600 BC, though. I mean—(Laughs) That would have taken a little foresight.

But Aesop, you know, in between tortoises and hares and all these other things, he found time to write about, you know, birds. And he said, “A bird in the hand is worth two in the bush.” Now, that isn’t quite complete—because the question is how sure are you that there are two in the bush and how long do you have to wait to get them out? Now, he probably knew that, but he just didn’t have time because he had all these other proverbs to write and had to get on with it.

So—but he was halfway there in 600 BC. That’s all there is to investing is, how many birds are in the bush, when are you going to get them out, and how sure are you? Now, if interest rates are 15%, roughly you’ve got to get two birds out of the bush in five years to equal the bird in the hand. But if interest rates are 3% and you can get two birds out in twenty years, it still makes sense to give up the bird in the hand because it all gets back to discounting against an interest rate.

The problem is, often, you don’t know—not only how many birds are in the bush but in the case of the internet companies, there weren’t any birds in the bush. (Laughter) But they still take the bird that you give them if in the hand. That—but it's—but I—I actually have written about this sort of thing, and the—stealing heavily from Aesop who wrote it some 2,600 years ago—but I’ve been behind on my reading.

Source: https://youtu.be/2a9Lx9J8uSs?si=hvfkap4Rvr_pCtVY

 

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