THE INTELLIGENT INVESTOR BY BENJAMIN GRAHAM
0:00we study billionaires in this episode 88 the investors podcast adjusting from Bel
0:14Air Maryland investors podcast
0:20since summarize the lessons waters tell you when it’s cold will give you
0:27investing strategies your host Preston Parrish and staying person has everybody
0:36doing out there this presentation of Yahoo’s for the investors podcast and as
0:40usual on the company by Mike Obel stick brodersen out in Denmark today we’ve got
0:46a book a lot of people talk about the author of the book is Benjamin Graham
0:51Benjamin Graham Road two books that were really famous person security analysis
0:56which we’ve done an episode on and then the other book is the Intelligent
1:00Investor so to just give everyone a quick background if you’re joining us
1:04for the first time on the show maybe don’t have Benjamin Graham is so
1:07Benjamin Graham was born buffett’s professor at Columbia and RAM started
1:12teaching at columbia university back in 1928 he wrote this book and it was the
1:17textbook that he used in his class and the text book was called security
1:21analysis which we’ve done the previous episode how many episodes ago was that
1:24stick like 20 or something like that yeah that sounds about right about
1:28twenty episodes ago and so when Graham wrote this book security analysis
1:32security analysis was published back in 1934 so all this was really kind of
1:37going on during the Great Depression and Graham then was professor for quite a
1:42few years he ended up being the professor for Warren Buffett and Warren
1:47Buffett whose net worth is I don’t know where it’s at right now maybe seventy
1:50billion 65 billion something like that it’s it’s way up there one of the
1:54wealthiest people in the entire planet has said that everything that he’s
1:58learned in his investing approach was completely shaped by Benjamin Graham the
2:02author of these two books and so that’s why we really like to place a lot of
2:07emphasis on Benjamin Graham he’s you know the founder of value investing a
2:13lot of people have attributed their massive net worth to following the
2:17principles of management so in today’s episode we’re gonna be reviewing the
2:22Intelligent Investor by Benjamin Graham and where this book is a little bit
2:26different than security analysis is that the intelligent investor’s a
2:30watered-down
2:31may be easier version definitely geared towards the common investor opposed to
2:37like a security analyst that does a professionally working for a big bank so
2:42this is for the common investor and how they can invest so what we’re gonna do
2:46sticking I came up with actually sticking up with the agenda I should say
2:49he email it to me
2:52sticking up with the agenda in the way he broke it out as he said president
2:55let’s do chapters one through seven in the first segment two Chapter II that’s
3:00a really important one and we’re gonna do nine through nineteen and then
3:04chapter 20 all by itself so we’ll talk about intrinsic value to all sorts of
3:09things in hopefully you guys enjoy this one so let’s go ahead and start this off
3:12gonna be reviewing the first seven chapters 1 through 7 he kinda hit in the
3:17highlights between the two of us so the book starts off with a very very
3:22important discussion and that discussion is distinguishing between an investor in
3:28a speculator so here’s the difference
3:323m says that in when you’re an investor do not seeking a massive return in a
3:37short duration or short period of time you’re looking for a reasonable return
3:42and so grand doesn’t necessarily say a reasonable return is 10% or less or
3:47anything like that he believes that really up to the reader to determine but
3:51I think gramm would probably say if you’re looking for a 50 percent return
3:55in a one-year span her one-year timeframe that’s probably getting into
3:59the room where you’re here you’re looking for excessive gains net really
4:03starts to become speculative in nature so the second part is that when you have
4:09an investor he’s doing something to promote the safety of the return of on
4:13the principle so that an investor won’t do anything they’re really compromises
4:18his principal in in any type of extreme manner so you know let’s say you were
4:22gonna invest in a large cap company let’s just say it was a company like
4:27Apple and you were looking at Apple’s returns and their revenues were really
4:31steady they had all these insistent numbers in the expectation is that
4:35they’re going to continue to earn at least the level that there
4:38earning today into the future and there’s no really anything to you can
4:43see on the horizon that would cause a major disruption in that in the next
4:47couple years that would be an example of investing because at this point I’m you
4:53can’t necessarily say the revenues or the net income is all over the place so
4:59it’s not something that you can actually projector predict where the bad event
5:03has been occur that’s where you get into more of an investing approach opposed to
5:07a speculative approach you know back in the day SiriusXM Radio their net income
5:12was up and down there moving stuff off their balance sheet on their income
5:16statement it was just kind of a mess if you look at their financials and so at
5:20that point I’m you could as an investor versus a speculator you could look at
5:24that pic and say you know next quarter they could have negative net income
5:29where they just had a positive one that could totally happen based off their
5:32track record in the things that have happened if you know that as a person as
5:36a person is looking to invest up front and you know it could potentially be bad
5:42you’ve identified an event that could jeopardize your principle which it now
5:48goes into we would then gramm would call speculation opposed to invest because
5:53you already know the event occurred really kind of come crashing down to
5:57thats it those are the two things you gotta be able to protect your principal
6:00and you’ve got to go after things that are giving new reasonable returns and
6:05that’s what he would classify as investing so here’s the direct quote out
6:09of the book he says investing is promoting the safety of the principal
6:13and an adequate returns that’s where I’m pulling that from and this is big I mean
6:18this is huge for a person to really kind of understand that I know it sounds
6:23really simple but if you aren’t doing that then you are speculating then you
6:29are saying I feel like this is the direction things are going to going
6:33anything he started throwing out the fuel word opposed to I have looked at
6:38the company’s cash flows
6:40they have been very consistent over the last five years looking towards the
6:45future I expect those cash flows to continue to remain consistent if not
6:50slightly grow and because of that when I do it discounted cash flow analysis
6:55taking those future cash flows and discounting them back to today’s present
6:59value I expect the value the company to be $35 a share at a 7% discount rate if
7:06it doesn’t sound like that that’s how do you know when stick and I are doing in
7:10the intrinsic value of an individual company that’s the conversation that
7:14were having in our head and that we’re actually writing out in order to return
7:18the values and here’s a really key point in all of that conversation were saying
7:23the competitive advantage of the company will be sustained or the expectation of
7:28the competitiveness will be sustained during that period
7:31those are the things were saying as an investor now on the show because it’s a
7:37lot more fun to talk about this kind of stuff on the show a lot of the times
7:40were talking macro
7:41we’re talking you know what we think from a speculative point of view yeah I
7:45think japan’s gonna be you know a disaster but we’re really kind of step
7:50in the realm of more speculation when we talk about that kind of stuff on the
7:53show then really how we invest our money yes so the way to think about investing
8:00is that is really really boring I think you might you have to have a quote
8:05something like that he’s been really be making his money just by waiting I mean
8:09if you think it’s fun just to wade and if you’re looking for action if you
8:14looking for a lot of things to happen really fast
8:17investing is prob enough for you as an investor there is no action all you
8:21would buy a company and you will hold it for ten twenty years perhaps the rest of
8:26your life so really think of investing at something that’s that’s really boring
8:31that’s there was actually my key point here
8:33extremely important point from chapter 12 chapter seven is the grants
8:38discussion about active and passive investing I think his definition of a
8:43passive investors really interesting today’s context because to the passive
8:46investor who is really talking about finding high quality pics and then just
8:50pulling onto them I think if benjamin graham was latched day he would probably
8:54say something like find an ETF has its week of value in that that’s how he
9:00would assume
9:01gramm would look at it has invested a really interesting thing about passive
9:07investing is that when reading the Intelligent Investor these guidelines he
9:11provides for it really saw the text I think they’re just timeless when I read
9:15that today I’m thinking that sounds like a great idea that’s probably where once
9:19you do if you had no opinion about the market if you have no opinion about the
9:23sustainable competitive advantage
9:25fine blue chip stocks with these given criteria in terms of dividend payments
9:29to church to financing and so on
9:31you probably do better on the most active investors with sticks really hit
9:36net in the book between passive and active RAM describes the book as the
9:41defensive investor in the aggressive investor and so here’s a quote from the
9:47book room has for the aggressive investor he says
9:51the aggressive investor will expect to fare better than as passive equivalent
9:55of his results may well be worse and he gets into a lot of discussion about that
10:00when he says that he’s aggressive investors their armed with all this
10:05information and they’re actively trading they’re using the speculative approach
10:09if you will and they’re actively trading in making all these decisions and he
10:12says it’s so is everybody else thats armed with that same amount of
10:16information and what he finds his these guys are going after trying to get a 12
10:23or 15 percent return are the higher end of this return to what they actually get
10:27his return is slower than the defensive investor who’s really just kind of going
10:31after may be called a seven percent return maybe a little lower in today’s
10:35markets then when Graham wrote this is back then you were at different you know
10:39interest rates in different multiples and stuff but now I think if you’re
10:43you’re going for 7% these days you might be stepping into something really risky
10:47I call this the activists actually if you read the book he was sometimes
10:51called the in surprising investor or the aggressive like I remember the first
10:56time I read this book I was like investing are there there’s only two he
11:02just uses a bunch of different rooms before lunch as well as a one one quick
11:06thing i really respect him as one of the biggest things in terms of investing as
11:11a writer I’m not really sure that was his forte you know you glad you brought
11:17this up because people need to be prepared cuz if you’re listening to this
11:20and you go out you buy his book it’s not an easy read it’s quite dry it’s
11:25difficult if there’s financial terminology that you’re not familiar
11:29with you’ll probably really struggle with this book even though it’s the
11:32dumbed down version of security analysis I remember the first time I read this
11:36because I didn’t have a background in financial accounting and things like
11:40that man that I struggle with this book I mean it was brutal I just knew is a
11:45really important read as Warren Buffett and all these other guys it said it was
11:48so important man when I first picked it up and said trying to read it I
11:52struggled it was very difficult
11:55yeah it is funny because in financial accounting us as many out is no we have
11:59a lot of different sense for the same things and obviously gramm you though
12:03he’s a professor he’s used teaching people he was just use all the almost
12:07like them or different terms for the accepted the same thing the better so
12:11it’s definitely not your jaw hurts textbook but just one quick thing I like
12:16to say about the active investor is that he would be saying bye unpopular stocks
12:22and the winner Ben Graham looks as though is that he’s showing people at
12:26staple of PE ratios and he’s actually saying and this is i think i read the
12:30book is written 1949 and already back then he was conducting studies in terms
12:35of how well companies perform if there is in this discipline terms of PE and I
12:41think he was just so much ahead of his time because he didn’t have a computer
12:44or anything like that disposal he just thought this would make sense then had
12:49conducted a lot of research in South OKC probably by a popular stocks mentioned
12:54on the on the p/e ratio basis I think that was really interesting in the last
12:59active investor and and this is something to return soon later in the
13:03broadcast is that he is always comparing price and quality he saying as an active
13:10investor welcome i buy high-quality companies but also by local it depends
13:15on the price so I just think that’s really the discussion customers reforms
13:20to talk about discount rate and the earnings thank all that is good is fine
13:26but we have to speak about what is the valuation and that’s why we have this
13:31conversation between the two of us and we’re going to talk a little bit more
13:34about intrinsic value later in the episode and you know we have a tool for
13:38calculating that stuff will hand off do so if you’re wanting that just stay
13:42tuned we’re going to get to a year later on so the next thing we’ll talk about in
13:46this group of chapters that were discussing right now which is 137 is
13:50inflation in corporate earnings so Rams opinion was that stocks are companies
13:57were somewhat inflation proof not a hundred percent inflation proves I don’t
14:03think that if you buy a stock that it’s going to be protected completely by
14:06inflation
14:08he said that a portion of it is protected now he doesn’t really kinda
14:13get into how you would sawyer figure out a mathematical number of how much of it
14:18is or is not be saying if you’re comparing it to a bond a bond is 100%
14:23impacted by inflation so in Jim Rickards talked about that a little bit in our
14:28interviewer he was saying you know if the inflation rate is is 5% in your
14:33interest on your bond is 3% well the person who who owns the bond is getting
14:38tore up there just getting crushed because the inflation rate is exceeding
14:43the money that they’re actually getting back so with a stock grant doesn’t say
14:48how much but you’re partially protected from that inflation peace now it’s
14:52really interesting I can’t remember the year that Warren Buffett Rule
14:55shareholder letter discussing this exact topic that Buffett talks about why that
15:00exists why companies are somewhat inflation protected and where Buffett
15:04gets into it is a company that has a lot of intangible assets on their balance
15:09sheets they’re actually protected more from inflation than a company that has a
15:14lot of tangible assets on their balance sheet and his reasoning is when the
15:18company has to replenish their inventory or they have to replenish their property
15:22or whatever that tangible asset is on the balance sheet when they had to
15:26replace that they have to pay the higher price of the inflated price of whatever
15:31it is that the replenishing it with it said that portion of the company’s
15:35revenues that then support the balance sheet sustainment and things like that
15:39thats whats impacted by inflation whereas if let’s just say you had an
15:43intangible asset like a brand or maybe digital media that you’re selling on the
15:48internet or something that the price can just be simply adjusted to the inflated
15:53price and you’re not really have to deal with inventory or anything like that
15:56where you’re having to pay a higher price so that’s where Buffett kind of
16:01went and took grams idea and took it to a whole new level now here he is taking
16:06his professors content and just elaborating on a more just kind of you
16:11can see how he does blossom some of this information that he learned as a young
16:14kid and
16:16just ran with it as an at all later on in his life if you ever heard it Warren
16:20Buffett talk about the intelligent investor who would say you need to reach
16:24after eight and you need to reach up to 20 so that’s also why I decided to have
16:29these four segments and one of them is 28 Mrs Mr market
16:34let me just try to describe the way that Benjamin Graham I describe this in his
16:39class so the way he like to describe it is he say imagine that you’re at your
16:44house and you’re just kind of sitting there reading the newspaper on your
16:47chair and the doorbell rings and so you go over and you open up the door and
16:52there’s a gentleman there he’s dressed up in a suit in his name is Mr market
16:56and so mister market comes to your door literally every single day
17:00the same time he rings the doorbell and he says hey I’ve got these companies
17:04that I want to sell you and he says I’ve got this one here it’s called XYZ and
17:09I’m selling it for $30 today yesterday it was $35 but today I want to sell it
17:15for 30 and he says I have company no ABC yesterday I was selling it for ninety
17:21per se i 100 for this one so the way he was describing it as each day this guy’s
17:28gonna come back with a different price sometimes he’s gonna one more sometimes
17:32he’s gonna want less sometimes he’s gonna want way less and you as the calm
17:39competent insistent balanced thinker that you are need to listen to what he’s
17:46offering you and then make your own conscious decision on what something is
17:51worth so whenever he comes and says company XYZ and it’s you know he wants
17:56to sell it to you today for $30 that’s his offer now what do you think it’s
18:02worth if you think it’s worth $50 will offer it to you for 30 well that’s a
18:06heck of a deal and you you should maybe buy some of that from him because he’s
18:10offering you agree price now the other company ABC if you want a hundred and
18:15you think it’s worth 75 why in the world would you buy that if he’s offering it
18:19to you for under that makes no sense and said this is the example that he would
18:25use in his classroom to teach students that it’s a choice the price that you’re
18:32being offered on the market is a choice for you to determine whether you think
18:36that’s a good place or a bad price
18:38we using your own analysis of what you think something is worth or the value of
18:43the intrinsic value would stick is talking about the prices just that it’s
18:48an offer it somebody saying hey I’m gonna sell you my car for $35,000 even
18:54though you could go to a lot right next to him by 4:25 it’s an offer you don’t
18:58get upset you don’t get angry does kinda look at it for what it is like a it’s
19:02about offered thanks and that’s why that chapter is so important so incredibly
19:07important facts exist in the interest of the book that Warren Buffett provides
19:11the preface that is one of the Warren Buffett made four points onus on a
19:17treatise out loud that says investing doesn’t require a high IQ Warren Buffett
19:22says successful investing as a result of implementing a sound strategy being able
19:26to control your emotions this book the Intelligent Investor provides the
19:31strategy and you need to provide the emotional control the next one is paying
19:35attention the chapter eight chapter 20 which we’re just talking about Chapter
19:40II and then the last one which is a really interesting point is outstanding
19:44results depend on three factors intellect effort research and the number
19:49of market swings you get the opportunity to experience and there is how he says
19:54the opportunity to experience a market swings so when you have a major downturn
19:58away Warren Buffett looks at that is an opportunity because he knows that price
20:03and value are completely out of whack and that’s his ability to really time to
20:08take advantage of the opportunity so thats chapter 8 it’s all about mister
20:13market its understanding that you’re being offered opportunities it at every
20:17single day there’s an opportunity because every single stock is priced at
20:21a different level and all these different emotion yeah now just want to
20:25ask you a quick question here president because this is a very public Christian
20:28so giving what you have told us about mister market and I heard you can time
20:34the market so the two opposite sassou paradox or other two different things I
20:39don’t see that is being two different things that also my opinion is not
20:45timing anything we should do now as you’re looking at all the different
20:48opportunities that exist at time now
20:52so as I look at a bond ten-year Treasury there’s all sorts of different bonds you
20:58got federal bonds you got corporate bonds communities you got all these
21:01things that all have a different level of risk that if I was gonna do it would
21:06love it was described as a zero risk investment that’s the ten-year treasury
21:10that’s giving me you know a one-point what is it 1.7 percent return somewhere
21:16around in that ballpark when I look at the you s equity market it’s almost it’s
21:20it’s 17901 the 26th of April when recording this has for me is very high
21:26but when you figure out what return and I’ll give you based off the the new
21:31earnings you’re at about 4 percent return where it’s been for the last year
21:35ever since we’ve been reporting this podcast it’s been four percent return it
21:39hasn’t really moved very much so when comparing those to this is the key point
21:44the yields are drastically different ones giving you double the return of the
21:48other but you have a lot more risk associated with one versus the other so
21:55now you ask yourself and this is where it becomes different for each person and
21:59every person’s gonna see this differently is the extra risk associated
22:03with owning a stock worth the extra two percent return that I’m receiving
22:09compared to a fixed income no zero risk investment you were talking about
22:14inflation is impacting bonds completely so if inflation which is inflationary
22:20now stick 1.7 it’s about the same yield is about the same yield is the ten-year
22:25Treasury so that now takes my return on the on the fixed income bond down to
22:30zero and then I have to say that some of that is actually impacting the stock as
22:36well it wouldn’t be the whole 1.7% in maybe half of that or something tonight
22:42you’re really looking at is your percent return to 3 percent return this is my
22:46thought process as I’m going through that and then I say is 3% and i’m
22:51looking at it and then a real terms here is 3% worth my risk of owning the stock
22:56market right now fully knowing that everything’s pretty much being
23:00manipulated by central banks at this point
23:02and I would say maybe not i mean that’s really kind of a hard question and I
23:07think that it’s not something that I can really say with a lot of confidence that
23:11I feel one way or the other I just think that there’s a lot of risk in equity
23:14markets just because of how much they’ve been manipulated when I look at how
23:18equity markets have been in am talking about the stock market and the stock
23:21market has been completely manipulated through quantitative easing those are
23:25the things that I think about from a macro standpoint to a micro standpoint
23:28to timing the market which cigs really kind of getting to with this question I
23:33look at it from what are my other options you better believe I’m
23:37constantly looking across that array of choices whether it’s fixed income
23:43equities commodities currencies what’s going to give me the best return at any
23:48given point I’m making that choice I’m not timing anything I’m just looking at
23:53what’s gonna give you the biggest yield yeah and I’m really happy a set that
23:56precedent because when people listen to the podcast hopefully there won’t be
24:00thinking okay so what Christmas days talking about is that if the Japanese
24:06central bank does this then this will have any influence on my portfolio
24:09that’s not what we’re saying and that’s different don’t want to talk to them I’d
24:13like that what I’m saying and will present the saying is that ok so when
24:17you are buying a car
24:19what’s the value of that car what’s the price of the car and that’s what we’re
24:22doing what stocks you don’t think about the stock market due tomorrow and I
24:26think a lot of people over thinking the question of can you top of the market
24:30you probably shouldn’t thinking like that you should be thinking what does it
24:33cost and what’s the value and just stop your thought process there and if you
24:37find good bugs you probably better off and time will really take the rest for
24:41you in a really gets back to the fundamental thing that gramm’s talking
24:44about in this book is are you speculating are you investing because if
24:49you’re investing you’re protecting your principal you’re putting your money in
24:54the things that you have no idea how it could go wrong that’s investing is when
24:58you’re saying hey this looks like a very good sound investment that has been
25:03consistent returns over time that concludes chapter eight let’s go to 919
25:09and kinda hit some of the high points here
25:11so if we should label chips in 92 chipped in nineteen is truly about how
25:16to find the right stocks and Ben Graham he’s much more specific in these chats
25:21as compared to the first seven chapters of miscrits serious just set up but the
25:25first thing I would like to talk about is him explain what is a discount rate
25:30and what is normalized earnings why is that important in determining the
25:34intrinsic value of a stock soon the thing that I was kind of surprised with
25:40in getting kinda to what sticks referring to here with the discount
25:42rates and when you’re reading security analysis which was his big first text
25:47book a lot of it was all about fixed-income bonds I’d say what the
25:52first 25 chapters are almost all about bonds and fixed income investments with
25:57this book with the Intelligent Investor it’s really kind of hope is to Ward’s
26:01common stock in really kind there’s some discussions about bosnia really he’s
26:06he’s talking a lot about stock investing
26:09and so he does not come out and say this is how you calculate the intrinsic value
26:13stock he doesn’t do that and what he does do is he talks about a discount
26:17rate talks about really kind of just looking at multiples of earnings to
26:23price and so let’s talk about intrinsic value and discount cash flow and all
26:29that kind of stuff so when you talk about free cash flow of the business
26:34that is the cash that’s left after everything is paid for and it’s the cash
26:40remaining in the bank account this number is so important because at the
26:46end of the day the money that the company brings in at their top-line
26:49their revenue that’s what is referred to the sales revenue there’s a different
26:54terminology and that’s where accounting kinda gets a little bit confusing cuz
26:57you hear people throw around these terms and sometimes they mean the same thing
27:00but your top line that if you had a let’s just say your business was selling
27:04pepsi’s in you charged $1 for a drink just to make the numbers easy that $1
27:11that you would receive is called the revenue or the sales at your top line
27:16whenever we say top-line that’s what we’re referring to that’s the $1 then
27:20after you pay your employees you pay for the medal in the can you pay for the
27:24sugar you pay for all the ingredients that make the drink all that stuff you
27:27pay your taxes after all that stuff is stripped away from that one dollar in
27:31that sale that top-line number you get to your bottom line which is your net
27:36income and that number might be ten cents and now they would make your 10%
27:41margin that’s what we’re talking about is that top-line and bottom-line number
27:45of what the company is able to retain from their sale so when you talk about
27:50free cash flow you’re really kinda getting into that bottom number that net
27:54income but she also have depreciation all these are the things that New York
27:58accounting for your eventually come into what is the company able to retain in
28:02cash after everything is said and done and that’s the number that’s important
28:08for determining the value of the business over time so when we look at
28:11the company’s free cash flow let’s say that we’re just gonna talk whole numbers
28:17of a business let’s say that a company is able to have a million dollars in
28:21free cash flow
28:22low this year and then they had $900,000 of free cash flow last year and the year
28:28before that they had $800,000 a cashless you can kinda see the trend here is that
28:33the companies basically adding $100,000 cash flow every year that’s a good thing
28:38that’s trending in a in a good direction that’s what you’re wanting to see when
28:42you’re looking for a business is determining that free cash flow so when
28:47you see that in there is no guarantee there’s absolutely positively no
28:52guarantee that that company will have that kind of cash flow moving into the
28:56future with what you’re looking for is a business that has some type of
29:00sustainability stability to it that use your reasonable expectation that in the
29:07future you can expect the same results so one that’s taking I really like to to
29:11use as coca-cola this is a company that has pretty stable results you can go
29:16back now there’s gonna be some fluctuations here and there is you the
29:20listener listening to this is your expectation that next year
29:23coca-cola’s going to continue to sell just about the same number of soft
29:28drinks if the answer is yes then that’s the tunnel company that we’re talking
29:32about the you can reasonably assess the value of it now appearance a pic of a
29:38business you think would be really volatile that you would say yeah they
29:41made a lot of money this year but maybe next year I’m not so sure they could
29:44maybe pull that off again those are the companies that Buffett doesn’t even try
29:49to figure out the value over Benjamin Graham try to figure out the value of
29:52because it’s really kinda hard to put a value on it now if the price is low
29:57enough yeah they’ll try to evaluate but for the most part they’re trying to find
30:01that steady stable business that they can actually determine that say I think
30:06over the next ten years they’re going to continue to have this kind of free cash
30:09flow and because of that they feel like they can have a lot of confidence in
30:14their ability to take those out up all his cash flows and then discount them
30:19back to today’s present value did they try to determine what the value is
30:22somewhat when we talk about a discount rate this is the thing you understand
30:26when you add up all your future cash flows so let’s just say next year you’re
30:31gonna earn a million the year after that you’ll earn a million and you go
30:35ten years into the future so you’re gonna make ten million dollars over the
30:38next ten years and what’s that ten million dollars over the spread across
30:43the next 10 years into the future
30:45worth today that’s the key thing you gotta figure out what’s it worth today
30:49opposed to the value ten years from now so in order to figure that out you need
30:55what’s called a discount rate in order to calculate what it is today we have
31:00this in all of our books we talk about this on Buffett’s books in fact we have
31:04a calculator though I’m actually figures this out for you on Buffett’s books will
31:07have a link for it in the show notes if you want to go play around with it but
31:10what you’re doing is you’re adding up all those future cash flows using a
31:14discount rate and so the discount rate that you typically use or the Buffett
31:19recommends that you use is the ten-year Treasury when you discounted back
31:23whatever interest rate you choose and I think the starting point is always the
31:27ten-year Treasury you bring that back its gonna say that the stock is worth
31:31$100 or $50 you obviously have to divide out the number of shares outstanding
31:36so this is kind of a process if you will and we have videos we have detailed
31:42videos that teach people how to do this and to be honest with you gramm doesn’t
31:47get into this level of valuation in his book he talks about it he says you need
31:53to do
31:54discount analysis you need to figure out what the present values today based off
31:59of the expectations of the company to earn in the future but he doesn’t get
32:02into these equations he doesn’t get into the math behind us and that was one of
32:06my frustrations with this book because I wanted to get into that I think for a
32:10lot of people out there they hear the discussion of how do I do this
32:14yeah you definitely representing because we all looking for that one stroller
32:18just tell us with insurance evaluate us compare that to the current market price
32:24but unfortunately is not that simple so we talk about the Disco is first how I
32:30teach my students to look at this is i teaching them about the opportunity cost
32:34first of all so it’s really important that’s also why Warren Buffett use of
32:40the ten-year treasury because that is an opportunity cost a risk-free investment
32:45intuitively that’s also
32:47Obagi would rather 11 told today that in a year because you had the chance to
32:51invest that dollar and get a return from that or that one year another thing to
32:56include is inflation if we have a high inflation would everything else demand a
33:01higher return on our capital also think is important to look at risk and compare
33:07that to the discouraged that using and the heart thing about this that there
33:12are no finite number that just say this is the perfect measure of risk and I
33:18think one of the best examples I come up with is that a lot of people have
33:21approached me and want to help me raise capital to their style company and
33:25whenever you are you in such a process and you would usually
33:29to raise capital to have to consult with them about so what do they think their
33:34companies worth how do they come up with the valuation of the company
33:38this all come back too discouraged because they were showing me all these
33:42graphs and all these prospects of how much money they will make and that might
33:47be all right but it is extremely risky it extremely uncertain and you the
33:52highest cash flows when you disconnect with the appropriate discount rate if
33:56it’s a risky company like a startup you’ll just see that that is complete
34:01reflected in the intrinsic value so if it helps with you to understand look at
34:07the discount rate and the earnings of the castles of Christmas talking about
34:10the four as two sides of the same crimes you have earnings but they have to be
34:15discounted giving the risk inflation opportunity cost so let me talk about
34:21where I kinda have a different opinion than Buffett and not necessarily
34:25grandpa’s gramm doesn’t necessarily say that it needs to be a ten-year Treasury
34:29use this discovery that’s much more Buffett that saying that I disagree with
34:34Buffett on that I think that the discount rate should actually be the the
34:37current yield of the S&P 500 that’s what I think should be used when you’re
34:42comparing an individual stock picking the reason I had that is because the
34:47reason I have that opinion is because of this if I go and I stick an individual
34:52company
34:53and I use in today’s example
34:56ten-year Treasuries 1.7% that’s gonna give me a much higher intrinsic value of
35:02a stock using a 1.7 percent discount rate then using what we think the
35:06current S&P 500 yield is which is 4% so if I use four percent compared to an
35:12individual company I’m actually gonna get a lower intrinsic value on that
35:17business because I used hired this country now the reason why I’m saying
35:21use the S&P 500 is because if you took an individual stock and you compared it
35:27to the S&P 500 you made both of them have the same yield in this example 4
35:32percent discovery I’m gonna tell you every single day of the week that the
35:37S&P 500 is lower risk than an individual company so why in the world would I use
35:44the discovery of the ten-year Treasury when I could be using something that’s
35:47giving me a more match if you will risk the end more conservative price estimate
35:56by using the current yield of the S&P 500 I think that’s a much more
36:01appropriate discount rate that’s giving you much more conservative estimate
36:05that’s apples to apples kind of estimate a because you’re using equities and be
36:11because you’re actually getting a much safer or much more appropriate risk
36:17appetite comparing a basket a 500 stocks to an individual stock but that’s my
36:22opinion I’m curious here with stick thinks about that idea well the thing is
36:26a good point that you have Preston and also thought about so if we do use the
36:32ten-year treasury does that mean that there is no risk and then you think
36:35because a solo I can see that the interest rate would work and saw
36:39territories but it doesn’t work today and perhaps at the time but it was
36:44saying it in my particular context and the interest rate might be allowed
36:47higher so I just think if you return to what you said before pressing when you
36:51said four percent for this be 500 to listen to the Treasury it doesn’t mean
36:56it’s just twice as a good the best way for me to explain this is that you hear
37:00about if you do have a
37:03a third percent higher chance of this disease that might be right but you know
37:07a third of a cent increase of nothing is still nothing I think that would be my
37:13take on some stuff explain what is the opportunity cost here because I’m
37:17looking at this opportunity cost and if you just picking an individual stock
37:22obviously there could be a management issue or they could be like something
37:27catastrophic have this company but if you own S&P 500 you own all the
37:31companies and you don’t have to spend time on it so I definitely see where you
37:34are where you come from this press with this idea can have originated with was I
37:39would get frustrated cuz people would go and use the intrinsic value on our site
37:43and get these emails and all these messages from people needs they would do
37:47the analysis they were calculated the value and they’d be using the ten-year
37:51treasury and it was like yielding you know 1.7% and they’re figuring out the
37:55intrinsic value these companies using a 1.7 percent discount rate because that’s
37:59the way Buffett says and they begin is really high market prices for different
38:04companies because this is the easiest way to understand it the lower that that
38:08discount rico’s the higher your intrinsic value numbers going to be on
38:12the company so is these interest rates continue to be manipulated by the
38:17central bank syndicate pushed closer and closer to zero the intrinsic value of
38:21all these stocks just get pushed to the moon you know i mean they just go
38:25through the roof and so i’m looking at that in a person would be saying yes
38:29company XYZ is worth a thousand dollars a share
38:33discounted at a 1.7 percent discount rate and I’m thinking man yes yes it is
38:39but you’re not accounting for the fact that with the Treasury you you’re gonna
38:44get your money no matter what the federal government’s gonna pay that back
38:47you’re going to get the coupon with the company you have no there’s tons of risk
38:52that the company may not be able to get those earnings and then you’re only
38:55discounting at 1.7 percent which is giving you this crazy price so that’s
39:00whenever I was like there has to be a better discount rate than the ten-year
39:04treasury that’s representative of a and equity to equity in this is totally
39:10geeked out on you when you’re talking about a bond you’re talking about a
39:13finite financial instrument
39:14it’s something that that will mature on a fixed date when you’re talking about
39:18an equity it’s something that goes into perpetuity
39:21so you’re already comparing apples to oranges as far as I’m concerned because
39:24you’re comparing a fine instrument to an infinite instrument when you’re talking
39:28equities and fixed income so I wanted something that was different than that
39:31that comparing apples to apples equities equities if you will and I also wanted
39:37something that had that compared a stock to start but it was also taking into
39:42account the risk appetite so for me when I look at the S&P 500 if you can’t match
39:48that
39:49if you can’t match that price and in fact if you can’t beat that price why in
39:54the world are you taking in individual stocks over the S&P 500 if you can’t
39:58beat it and so that’s why I like using the current yield keeps killer I know
40:03that the people listening as may be frustrated I think there’s a few people
40:06out there that are listening to this that are maybe really enjoying the
40:09conversation because we are really getting into the weeds and some hardcore
40:14finance and accounting type stuff but this is really important if you’re a
40:19person is actually calculating values of businesses and not just kind of
40:23selecting things on an emotional level but you’re actually doing some math to
40:26figure things out and to be honest with you one of the first things the gramm
40:30talks about in this book is if if you’re an investor and you’re figuring out the
40:35value something there needs to be math associated with what you’re doing it so
40:40that’s why we’re really kind of going down this path and talking about the
40:43math behind terming the value of a company yeah just continuation that
40:49person I’m sure you experience the same but I get so many emails that talks
40:52about the intrinsic value and also hello emails from people say could you discuss
40:57that more in the show so good news and bad news we just did that and you just
41:02saw how complicated it is and also wanna say it has something to do with the
41:05participating because we thought about this man’s house before she would talk
41:07more about the value and you can just hear that we’re talking about this we’re
41:11talking about grass we’re talking about math a podcast is just really hard
41:15medium to explain that and if it just comes another example so if you look
41:20specifically in the Intelligent Investor then been crammed with say you can use
41:25these rule of thumb when you’re looking at earnings you look at those limited to
41:30ten years and then you would wait and different compared to how long has been
41:34since they had earnings now I’m sure a lot of people would understand what
41:38about asset here but it is not difficult to explain but it’s difficult to
41:42illustrate and simplify speaking on podcast so that would be my disclaimer
41:47for not doing it before so if you really frustrated about this competition
41:52espresso set before we have some videotape illustrates this is not
41:55because we don’t want to talk about the podcast but it’s hard medium to do so
42:00yet definitely go to the show at this stuff picture interest you wanna learn
42:03more about it or shown as we have links to the intrinsic value calculator which
42:08has the video is on the same page that teaches you how to where to find the
42:12data to plug into the calculator how to think about some of the stuff we got all
42:17that on the on the web sites just go to the show and it’s so we’re gonna skip
42:21over a bunch of the stuff between those chapters and directed chapter 20 which
42:25is a really important discussion one of the chapters that warren buffett said
42:28that we need to focus on in the Intelligent Investor thats discussion
42:32about margin of safety and how important this is to investing so the best example
42:38that I think Buffett provided that people can easily conceptualize and
42:42think about is the idea of a truck crossing over a bridge too but it’s as
42:48if your gonna build a bridge that can support 10,000 pounds and drive across
42:53the bridge how strong would you build a bridge would you build it so that it was
42:58ten thousand and one pounds that it would support you build the bridge so
43:03that it would be a good sport 15,000 pounds and it’s such an easy discussion
43:09for people to have but it doesn’t necessarily have an answer
43:14it’s really kind of a mean if I was the person building the bridge and say ok
43:18what confidence level do we have that the trucks gonna wait ten thousand
43:21pounds will kinda whether we can have and what kind of environmental
43:25situations that we have in this area where the bridge is gonna be built
43:29there’s all these different considerations have been at the end of
43:31the day you’re gonna kind of make a swag if you will as to what margin to see the
43:38year comfortable building the bridge yet so you know off the top of my head and
43:42say I will build it for fifteen thousand pounds of the heaviest vehicle gone over
43:4610,000 that were you have your margin of safety so when it comes to investing
43:51it’s the exact same thing is you’re wanting to buy a company and you can get
43:56two percent return on it on a ten-year Treasury and a company is priced at a
44:03two percent yield
44:05it’s a no brainer you by the ten-year treasury because the yields of the same
44:09this is assuming that inflation is is nothing just ease so that’s an easy
44:14decision because the bond is a lot lower risk than the equity for the stock and
44:19that’s where he’s getting into this margin safety so how much above that
44:24ten-year treasury prices soar above the you you’d expect to get out of the S&P
44:29500 how much above that you need in order to make a selection on an
44:34individual stock pick so if you’re out there and you’re dating the intrinsic
44:39value of General Electric and I don’t know if the intrinsic value generalities
44:43but let’s just say the you determine it is 5% or 6% is that margin that one or
44:50two percent is that extra one or two percent above the S&P 500 giving you a
44:54four percent return worth your risk I can’t answer that I don’t know that’s
45:01completely up to you to determine what that margin of safety needs to be in
45:05order for you to make that selection but thats would buffett’s getting into here
45:09where you’re you’re jumping from one risk scale to the next where S&P 500 is
45:15lower risk than the individual stock pick in the ten-year treasury is less
45:19risk than the S&P 500 you have to make that determination of where you’re
45:23satisfied assuming more risk for the yield that you’re potentially going to
45:28get that’s a keyword potentially going to get and it’s really kind of up to you
45:33to determine that I think the discussion and for a lot of people just thinking of
45:37things in that context is a really important to stick imperious to hear
45:42your thoughts on this margin of safety stuff
45:44well I think I agree the person actually if you saw I was either forcing
45:51something it wasn’t so much about the homogeneous safety it’s one of those
45:54things that either you get it or just don’t think the vast majority of people
45:59out there that was saying rich 10,000 pounds fifteen thousand pounds it makes
46:03a lot of sense and then you have other people in the might not listen to this
46:07podcast saying oh so I saw that the stock was down 4 percent yesterday so
46:12it’s probably gonna bounce today I mean it’s just different ways of looking at
46:16stocks and if you accept the whole notion above that price and value is two
46:21completely different things I think the margin of safety because it is extremely
46:26powerful but also thing is so simple that if you have the right mindset you
46:30could probably have figured the whole thing out faster than we could explain
46:34it because it’s just so obvious but if I should talk about the intelligent
46:39investor in general rule and when I was missing because I would really like a
46:43discussion about competitive advantage and in one who knows about gramm now
46:49percent stake that doesn’t make any sense that you say that because Benjamin
46:52Graham he’s very core insists he’s not saying this company do well because they
46:57have valuable intangible assets or he would not be saying this company would
47:01do well because they have a strong brand that’s not his type of investing just
47:05wanna throw that out to you guys out there if you looking for D one book and
47:09you heard about everyone saying should be the best because that’s where you can
47:14really see a big investment philosophy now say yes the latter is true this book
47:18is a virus HCV investment philosophy Justice Warren Buffett but still if you
47:23want to do
47:24active investing and if you want to do active investing like Warren Buffett is
47:28doing then you also need to have the qualities of pot included and I think
47:34that was something I was missing from from this book i second wraps up our
47:40summary the Intelligent Investor one of the things that I want to throw out
47:44their tour audience ticking higher kind of working on creating more value for
47:48our audience building new things into our website and things like that so
47:52one of the things it we talked about a few times on our show is when we look at
47:57our own personal business we kind of break it into two different segments you
48:02got the the operational side where you’re creating assets like this podcast
48:07this is an asset for us that’s reading a cash flow for are you know our personal
48:12business you might have a business of your own you might have a
48:15brick-and-mortar story might have a digital online store whatever it is
48:19that’s creating a caste flew for yourself once you create that cash flow
48:23you then have to be able to invest the retained earnings of that cash flow and
48:28that’s what we’re typically talking about on our show is that second part
48:31where would you do with this money once you have it whether it’s your salary
48:36whether you’re on business and like today we’re talking about investing in
48:39stocks were talking about how do you take that cash flow and purchase another
48:44asset that somebody else has created in order to own a piece of equity in that
48:49business we’re trying to do is talk to people and maybe teach people how to do
48:56that first part where you’re creating online assets are you’re creating equity
49:01in some type of business or you’re doing something that’s creating a cash flow
49:06stream for yourself and so in order to do that what we’ve done is is we’ve
49:10gotta do mean that’s going to point you back into the investors podcast website
49:15but we’re trying to create videos and tutorials in order to teach people how
49:19to create income
49:22specifically passive income because that’s what we’re that’s what a lot of
49:25our assets are for yourself and so we purchased the demand create passive
49:31income as you type that into your web browser create passive income it’s going
49:35to take you to a page where we’re creating tutorials and video courses for
49:39people to learn passive income investing stock investing all sorts of things but
49:45if you go there to create passive income you’re gonna be able to see some of the
49:49products it’s taking iron ore building so one of the products that state just
49:53recently bill is a chapter by chapter video course of the Intelligent Investor
49:59so let’s just say you got you buy this book that we just got done discussing
50:03and you’re going through and it’s difficult for you to understand stick
50:06created a chapter by chapter course video-based course where he teaches
50:12literally every chapter of this book so that’s something you be interesting go
50:16to create passive income dot com and you can see the course that stayed till
50:20we’re actually creating other courses in the process on the little bit slow not
50:25as quick as stick but the process of building a course on how to how to stand
50:32up and create your own podcast so if you’d like to do maybe you maybe your
50:37specialization in hunting or whatever it is I don’t know and maybe you want to
50:42create your own podcast and talk about this kind of stuff I’m trying to create
50:46a tutorial video that shows you all the equipment we use kind of how we do our
50:51share all that kind of stuff but that’s something that we’re trying to build out
50:54for community so that you can start creating different online assets digital
50:59assets for yourself if that’s something you want to do if not no sweat you can
51:03just completely ignore all that I want to throw that out there for people so
51:07that they know that it exists so that concludes our episode for this week on
51:12the intelligent investor who for you guys enjoyed our conversation we
51:16apologize if we got a little too technical over the audio format but if
51:20we did and you wanna see more stuff on video we got the buffets ebooks
51:23tutorials which are completely free all the calculators all that stuff is free
51:28of links in the show notes for that so thanks for joining us this week and
51:33we’ll see you guys next week thanks for listening to the investors bought gas
51:38to listen to more shows or access to the tools discussed on the show be sure to
51:42visit www.ambest.com submit your questions or requests a guest appearance
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51:57Buffett accounting book this podcast is for entertainment purposes only
