One of the best resources for investors are the Daily Journal Annual meetings chaired by Charles Munger. These meetings are full of valuable investing insights for investors. One example is the 2016 Annual Meeting in which Munger was asked, “What do you use to value a business or a company? How do you use the discount rate to calculate intrinsic value?
Here is his response:
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Charlie Munger: Obviously, it’s relevant what the return you get on your bonds is, that affects the value of other assets in the general climate. Obviously, your opportunity costs should cover your own investment decision making. If you happen to have a rich uncle who will sell you his business for percent of what it’s worth, you don’t want to think about some other investment.
If the opportunity cost is so great, considering everything else, you should forget about it. And most people don’t pay enough attention to opportunity cost. Bridge players know about opportunity cost. Poker players know about opportunity cost. But in an MBA faculty members and other important people, they hardly know their ass from a plate of hot squash.
Questioner: When you try to arrive at a valuation number using the discount rate, does it mean that between the two rates––
Charlie Munger We don’t use numeric formulas that way. We take into account a whole lot of factors. It’s a multi-factor thing. And there are tradeoffs between factors. It’s just like a bridge hand. You have to think of a lot of different things at once. There’s never going to be a formula that will make you rich just by going through some horrible process. If that were true, every mathematical nerd who gets A’s in algebra would be rich. . . .
So you have to be comfortable thinking about a lot of things at once, and correctly thinking about a lot of things at once. And we don’t have a formula that will help you. And all that stuff is relevant. Opportunity cost of course is crucial. And of course the risk-free rate is a . . . factor . . .
Questioner: Do you use the same rate for different types of businesses?
Charlie Munger: No, of course not. Different businesses get different treatments. They all are viewed in terms of value, and they’re weighed one against another. But a person will pay more for a good business than for a lousy one.
We really don’t want any lousy businesses anymore. We used to make money betting on reinventing lousy businesses and kind of wringing money out of them, but that is a really painful, difficult way to make money, especially if you’re already rich. We don’t do much of it anymore. Sometimes we do it by accident, because one of our businesses turns lousy, and in that case it’s like dealing with your relatives you can’t get rid of. We deal with those as best we can, but we’re out looking for new ones.
You can find a partial transcript of the 2016 Daily Journal Annual Meeting here.
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