Our valuation approach is simple. Investors own securities for one reason-to get paid. Stocks and bonds are simply claims on the future cash flow generated by the underlying assets. The present value of those future free cash flow streams is the Intrinsic Value of the securities.

Intrinsic Value estimates will only be as good as the estimates of the value drivers for the underlying business–sales, price, cost, margins, tax rates, capital requirements, and cost of capital-behind the calculations. These value drivers are strongly influenced by government policies.

From time to time the interactions of buyers and sellers in the asset markets result in market prices which we find to be significantly above or below the Intrinsic Value of the securities. That’s when stocks or bonds are over-valued or under-valued. Investors who consistently buy securities when they are undervalued, and/or sell securities when they are over-valued, will earn a higher-than-market return.

For a more detailed discussion, see Tracking Value.

Intrinsic Risk

Risk does not mean volatility; risk means losing your money. That happens when a business fails to deliver the operating performance embodied in the price an investor paid to acquire it. We call this Intrinsic Risk, and we measure it by explicitly estimating the probability the Value Drivers that underlie a market price fail to deliver the implied free cash flow stream.

Back to How We Think