r/valueinvesting
Buffett gave us four investing criteria. The fourth one depends on a number nobody else can verify.
Critiques Buffett's 4th criterion (attractive price) as subjective, noting intrinsic value estimates vary wildly based on assumptions, unlike the first three objective criteria.
- Intrinsic value is an unobservable estimate highly sensitive to input assumptions like growth and discount rates.
- Two disciplined investors can derive vastly different fair values for the same asset, leading to contradictory investment decisions.
- The 'margin of safety' concept lacks falsifiability, allowing investors to rationalize holding losing positions by adjusting their internal valuation models.
In his 1977 letter Buffett laid out what he wants in a business, and the wording is worth quoting exactly: "We want the business to be (1) one that we can understand, (2) with favorable long-term prospects, (3) operated by honest and competent people, and (4) available at a very attractive price." I keep coming back to that fourth one. After 12 years of investing I think it works differently from the other three, and it took me a while to see how.
The first three you can reason your way toward. Understanding the business is just study. Favorable long-term prospects means a durable moat, and you can assess whether the high returns survive competition. Honest and competent management shows up in capital allocation and how they treat shareholders. Hard work, but two careful people looking at the same evidence usually land in roughly the same place.
The fourth is different. And to be fair to Buffett, he did define it, more than people give him credit for. His answer is margin of safety: the gap between price and intrinsic value, with intrinsic value estimated through owner earnings discounted back. That is a real method. Far more rigorous than the P/E and P/B comparisons most people actually use. It is the core of what Graham taught him.
The problem is that intrinsic value is not observable. It is an estimate, and it depends entirely on the assumptions you feed it. Two disciplined investors run owner earnings on the same company, pick slightly different growth and discount rates, and come out with fair values 40% apart. Both are following Buffett to the letter. Both have a margin of safety against their own number. And they completely disagree on whether to buy…
That is the weak point. Margin of safety measures price against a number you made up yourself. It can't really be falsified, because if the stock drops you just say the market hasn't caught up to intrinsic value yet. The first three criteria anchor to the business. The fourth anchors to your own estimate, and you are the least objective thing in the room.
The honest version of the fourth criterion has to anchor price to something outside your own head. And there is one number that fits: every market price already implies an expectation about future growth, and that implied number is the same for everyone looking at the stock. So instead of asking whether the price sits below my private estimate of value, the better question is whether the growth the price implies is something the business can actually deliver, given its returns on capital and how much it can reinvest. That comparison doesn t run through my assumptions. It compares two things anyone can check.
That is the version of "attractive price" I think Buffett was approximating with judgment for decades without ever writing it down. Curious how people here actually judge it. Margin of safety on your own intrinsic value estimate is the standard answer, and it quietly leans on the one input nobody else can verify.
Later he changed his stance to ‘At fair price’.
I use the method that you describes - use the current stock price and check how much growth rate is priced in, and check the growth rate against similar companies to see if it’s reasonable. I find it quicker than full DCF, and simpler.
Good way to do it. The comparison to similar companies is useful as a sanity check, though I’d also run it against the business’s own historical ROIC and reinvestment rate, because what the sector implies and what this specific business can actually sustain are sometimes very different numbers! The sector comparison tells you whether the implied growth is unusual. The fundamentals tell you whether it’s achievable.
The market can be wrong. The market price is a short term number, as are all metrics derived from that price.
The NIfty 50, Internet companies during the .COM boom - The Market all decided those were worth of 60 70 80 100 multiples and higher. Turns out they were 1/2 that (at best) and 0x at worst and if you anchored to those multiples and prices, you'd have lost your azz.
You are trying to use price as a proxy for value. Price isn't a reliable proxy for value - the price is just what 'Mr. Market' has decided at that moment.
The 4th criteria is, by nature, individual, and what 'attractive' is varies depending on the risk appetite of the individual.
The science gives you the floor, the art is everything above it. You can measure whether the implied growth rate is realistic, whether the ROIC is durable, whether the reinvestment runway is real . What you cannot measure is when the market decides to agree with you, and that part is always the art. A correct thesis can feel wrong for years before it pays off.
That's what circle of competence is for. You can't simply tally random people's opinion about intrinsic value.
If you bring a patient to a plumber, an architect and a marketing executive, you'll get wild diagnosis.
Bring the patient to qualified doctors, who's gone through med school and with significant years of experience. Such doctors won't wildly disagree in their diagnosis.
I use 2 methods Intrinsic Value and Fair Value. Wonderful companies should have these values pretty close.
- DCF Intrinsic Value (Buffet style) - projected owner earnings (OCF - upkeep spending) forward 10 years, then discount each year back at 15% per year (minimum required)
- Fair Value - projected EPS forward 10 years at historical growth rate, applied marked multiple (PE), then discount each year back at 15%.
Note: DCF will diverge significantly for companies where historical PE is high (inflated sticker) or where owner earnings ≠ reported EPS (capex-heavy businesses).
Fair price doesn't mean acceptable returns. Buffet didn't buy AAPL at PE 20 when this is likely fair. He bought it at PE 10, way below a value that will give just acceptable returns. I think Buffet is way more conservative than the average investor.
We look at a multiple and make judgements all the time of 'I don't think the company can grow at this rate to justify this multiple'. There are multiples we can look at and say 'this is unrealistic', but those generally don't happen nowadays because everyone has a computer at their fingertips to run a DCF and figure out 'this can't happen.'
It seems (to me) just as arbitrary as intrinsic value estimates, and maybe worse because you're tying your judgement of fair/not fair to a number (multiple) that moves daily, sometimes significantly for too often no reason at all.
Good discussion. I probably don't understand what you are getting at (a me problem).
You’re understanding it fine, and the objection is fair. The implied growth rate does move daily with the price. The difference is what you compare it against. A P/E moving from 25 to 30 tells you sentiment changed. A reverse DCF moving from 12% to 15% implied growth tells you the market now requires the business to sustain a rate its own historical ROIC and reinvestment have never produced. Same daily movement, completely different information.
Great - thanks for clarifying that I'm not as dumb as I was thinking I was 😃
Good discussion!
Typically you want to triangulate using more than one valuation methodology.
This is a very long tiresome post.
I’ll cut it short. Munger fixed buffet later on. Your 1977 is too old. He changed his way. Buy great companies at a fair price was the later paradigm. See how short this was??
True that nobody has a crystal ball, and I see KHC is the right example looked like a quality compounder right up until it wasn’t. But there is a difference between accepting uncertainty and treating all estimates as equally arbitrary. The goal is not to eliminate the guess, it is to make the guess depend on fewer (unverifiable) assumptions. A price implying 25% annual growth for ten years is more fragile than one implying 8%. Both are uncertain, but not equally uncertain. That asymmetry is where I think the real work lives.
Well Berkshire he essentially liquidated, sold off all the assets.
But generally he was passive, bought a waited for a rerating.