w w w . t i c o n l i n e . c o m

Munger's Intrinsic Value

In my article entitled "Intrinsic Value" I suggested that it may not be appropriate to use Robert Hagstrom's version of Warren Buffett's intrinsic value theorem if one plans to sell the stock in the future. I still maintain this position because of the large, and extremely hypothetical, Residual produced by Hagstrom method - a method that extrapolates the worth of a constant stream of cash from year 11 to infinity.

Instead of determining the worth of a constant stream of cash forever, I tried to determine a liquidation value for the company at year 10. This liquidation value could be added to the 10-year sum of owner earnings produced in the first part of the method to arrive at a better approximation of the company's Intrinsic Value.

The liquidation value may be based on the company's year 10 net worth, as a going concern or 0. Apparently, Charlie Munger, the infamous investing partner of Warren Buffett, prefers to use the company's equity value, but with a slightly different slant. He prefers to use the year 0 equity value. As Haywood Kelly reported on Morningstar's website:

[Charlie Munger] starts with shareholders' equity as an approximation of Wesco's liquidation value--what it would be worth if it sold off its assets, paid its creditors, and distributed whatever was left over to shareholders.
1998 Haywood Kelly, Morningstar

In this piece Mr. Kelly was describing Charlie Munger's method for determining Wesco's intrinsic value (Charlie Munger serves as chairman of Wesco).

It is interesting to note that Mr. Munger uses the company's present (year 0) equity to add to the company's future earning potential to arrive at an intrinsic value. I'm still turning the idea over in my head. In some cases I feel it may be 'more accurate' to use an extrapolated year 10 equity value discounted to the present. However, the year 0 is definately more conservative and is not prone to the errors associated with extrapolation.

As usual, it is up to the user to determine what he/she feels most comfortable with. If you are sure you have a good thing on your hands, you may wish to commit yourself to the extrapolation. If you are not, then perhaps taking the year 0 equity value is good enough.

Cheers,
Jim Chuong