Question

How did Buffett determine intrinsic value? Also, I know cost approach is different from intrinsic value but are there any other alternatives?

Answer 1

Intrinsic value is the most widely accepted valuation method based on discounted future cash flow forecast. Key elements to determine intrinsic value are:

1. Good estimation of future cash flow estimates - based on fundamental analysis, for as far in future as feasible.

2. Discount rate - based on investors hurdle rate / other best available investment opportunity

3. Long term growth, margins and capital efficiency assumptions to calculate terminal value. Ideally, we would like to keep the explicit cash flow forecast period to be such that it accounts for 80% of total present value and terminal value is say 20% (roughly) though it varies in practice.

There are three major valuation techniques:

1. Intrinsic value - as described above

2, Cost Approach - The value of asset is determined in terms of the cost it will take to recreate the asset from scratch today

3. Comparable Approach - Here, value of asset is estimated based on value of other similar assets for which value is know.