Mental Models discussed in this podcast:
- Intrinsic Value
- Extrinsic Value
- Define your terms
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Show Outline
Extrinsic Value vs Intrinsic Value Definition
- Tweet:
- “Be very careful when describing an asset’s “value.”
- Define your terms. They matter.
- Intrinsic value is the NPV of all future distributions of cash. (Not the NPV of FCF)
- Extrinsic value is the market value as determined by others for any reason at all.
- Responses:
- This is an extreme view
- What about Berkshire? What is their cash worth?
- My thoughts:
- “There is no fundamental difference between equity that doesn’t distribute cash *ever* and a bond with a 0% interest rate that not only doesn’t make interest payments but also defaults prior to returning your principal.
- How much would you pay to own that bond?
- “If I knew *with certainty* that a business would never distribute cash. (Dividends, buybacks, or liquidation)
- Then the company is fundamentally worthless to shareholders.
- It means all of its growth is for nothing because it will reach bankruptcy before giving cash.
Summary:
Be very careful when describing an asset’s “value.” You need to define your terms because they matter. Intrinsic value is the Net Present Value of all future distributions of cash. (Not the NPV of Free Cash Flow) Extrinsic value is the market value as defined by others.
By focusing on intrinsic value investors can alleviate the need to predict price action in order to turn a profit. Investors, as opposed to speculators, earn their return from business performance. Therefore, it is critical to focus your time and effort on studying business performance.
