IV... and your estimation

[JBird]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

Consider a 1 year pure discount note, par value 100. The risk free rate is 10%. Assume that note pays you on time. The IV is 90.90- and that doesn't change from Day 1 to Day 365. And The Second Coming happening on Day 366 doesn't change the fact that IV was 90.90.

 

I must give credit to Eric. He is explaining this concept so well.

[ERICOPOLY]

OK, so an argument like, "Stock always go up (provided we exclude from the sample set any stock that goes down)", or "Newtonian gravity represents perfectly the way the universe works (assuming we ignore the big or the small)", or "All swans are white (assuming Australia doesn't exist)".

 

Non sequitur.

 

 

Basically, your proposition is built on asserting that the universe doesn't have any properties that refute your proposition.  So it's kind of an approximate model for the universe with huge known flaws rather than actually trying to represent the real universe.

 

An omniscient being knows everything (inclusive of IV).  How is my proposition flawed?  What are the huge known flaws?  So far you have found none, you have only suggested that each parallel reality has an IV of it's own.  That's fine, because we experience only one reality.  That's not a flaw, it's a feature.  In your coin toss example, think of the alternate outcome as a fork() in unix, where the alternate path takes place in a new process instance.  There is still one true IV per process instance because what we think of as ourselves is bound to a single process instance where there is a single IV.  Once again, let me suggest that it isn't "known" that there is a multiverse.

 

Ok, in that case your proposition is true, other than the time issues boiler raises.  (You could just go all the way and say that the intrinsic value of every company is zero, since, at the heat death of the universe, all stocks and all distributed earnings of those stocks would be worthless.  But I'm guessing that you wouldn't like either.  I kind of like that one though, because it says that the intrinsic value of every company is fixed and knowable, which is kind of cool.)

 

I haven't found a time issue that Boiler has raised.  The IV of a business is all future cash it makes, discounted to the present.  You can take that cash and throw it over your shoulder and claim that none of it is left, however it was still made by the business.

[RichardGibbons]

Sorry, I don't know how to fix the quote above.  Sanjeev, can you do it?  (Or delete it.)

 

The huge flaw is that you're completely excluding one of the most likely theory for how the universe works, and pretending that it doesn't exist because it doesn't match your theory.

 

It's fine to do it, in that Newtonian physics still approximates the world.  But it's a limited model that refutes other theories by assuming them away.

 

(Sorry for the rushed response.  I'm about to go on vacation for a week, and won't have access to the internet.)

[wknecht]

If the intrinsic value of a company never changes, then all companies that ever existed, exist today, or will exist in the future have the same IV. Eventually they will all be worth zero.

 

Consider a 1 year pure discount note, par value 100. The risk free rate is 10%. Assume that note pays you on time. The IV is 90.90- and that doesn't change from Day 1 to Day 365. And The Second Coming happening on Day 366 doesn't change the fact that IV was 90.90.

 

I must give credit to Eric. He is explaining this concept so well.

I see nothing special about day 1. Why wouldn't the IV change on day 2? Given an appropriate discount rate (separate discussion), present value is a function of time.

[ERICOPOLY]

Sorry, I don't know how to fix the quote above.  Sanjeev, can you do it?  (Or delete it.)

 

The huge flaw is that you're completely excluding one of the most likely theory for how the universe works, and pretending that it doesn't exist because it doesn't match your theory.

 

It's fine to do it, in that Newtonian physics still approximates the world.  But it's a limited model that refutes other theories by assuming them away.

 

(Sorry for the rushed response.  I'm about to go on vacation for a week, and won't have access to the internet.)

 

The theory is extensible to a multiverse, as I have pointed out.  There is one IV per universe.

 

You merely suggested that there is one IV per universe.  Exactly as I claim.

[JBird]

I see nothing special about day 1. Why wouldn't the IV change on day 2? Given an appropriate discount rate (separate discussion), present value is a function of time.

 

You've pointed out a nuance which I think is correct. It's a different point than Eric and I are trying to make, so I'm worried it will confuse the discussion.

 

If we stick with my 1 year note example- what we're trying to say is that from the perspective Day 1, the IV of the note is set in stone- because the future will only have 1 outcome.

 

What I think you're pointing out is that the IV calculation changes depending on which Day you look at the note. Clearly the NPV figure of the note is much higher if you're looking at it on Day 364-- its almost 100.

 

And you could say, Ah-HA! IV has changed! But then you've missed the whole point.

 

What we're saying is that if you're calculating the NPV of the note Day 1, there can only be one correct answer. Likewise- if you're calculating the NPV of the note on Day 364- there can be only one correct answer.

 

 

[ERICOPOLY]

(You could just go all the way and say that the intrinsic value of every company is zero, since, at the heat death of the universe, all stocks and all distributed earnings of those stocks would be worthless.  But I'm guessing that you wouldn't like either.  I kind of like that one though, because it says that the intrinsic value of every company is fixed and knowable, which is kind of cool.

 

No.

 

Intrinsic value of the business is measured by all of it's generated distributable cash, discounted to the present.  The distributed cash is certainly included by the omniscient towards the IV calculation -- it's not lowered by actions of the business owner post-distribution.  He can roll up the dividends and smoke them, or let them sit there in his separate account until the "heat death of the universe".  Now, the omniscient won't include any assets still belonging to the company at the time of "heat death of the universe" -- after all, they're not distributable.

 

Businesses can also be wound up early with the remaining assets sold and distributed to the owners (before the "heat death of the universe").

 

Now, under the current dividend policy Berkshire may well become a zero as nothing will have been distributed on the day that the heat death arrives.  It's really risky what Buffett is doing here -- perhaps you can point out this risk to him at next years AGM.

[jay21]

 

Basically, your proposition is built on asserting that the universe doesn't have any properties that refute your proposition.  So it's kind of an approximate model for the universe with huge known flaws rather than actually trying to represent the real universe.

 

 

Yeah, that's what I am kind of getting as well.  Here's how I am summarizing the conversation in my head.  Please let me know if I am misunderstanding the major thoughts.

 

Eric:  An omniscient person would know all the cash flows a business will generate.  These cash flows determine the singular IV of the company.

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

[ERICOPOLY]

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

 

Pre-determinism is a straw man.  It is not a requirement for singular intrinsic value per universe.

 

I have mentioned that each universe has but one past.  And each will have but one eventual future.  Just because it will have but one eventual future does not mean that it is predetermined.  It's just the way things actually are.  You go through life and at the end (looking back) you have a singular history.  Therefore, when you were born there was but one not yet determined path that you would travel (out of many that you could have potentially travelled).  Now, after travelling whatever path you travelled through your life, there was only one of them that you actually travelled on a per-universe basis.  At birth, you have but one not yet determined future path per universe (out of many possible paths per universe).

 

The concept of the omniscient being is just an instructional aid.  You compared the instructional aid to predeterminism, and then threw it all out together under "predeterminism".  Perhaps somebody can help me correctly label what logical fallacy that is filed under.  Is it guilt by association, or red herring, straw man, or what?  Or a combo?

[ERICOPOLY]

Forget about omniscience for a moment.

 

Take a person who is 100% lucky all of the time.  Ask him to take a guess at the company's future distributable cash flows and proper discount rate.  That's the singular IV of the business.  Without determinism!

 

It might be unnatural to find somebody that lucky, but I'm not arguing that it's natural for somebody to be that lucky.  It is an instructional aid.

 

[enoch01]

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

 

Pre-determinism is a straw man.  It is not a requirement for singular intrinsic value per universe.

 

I have mentioned that each universe has but one past.  And each will have but one eventual future.  Just because it will have but one eventual future does not mean that it is predetermined.  It's just the way things actually are.  You go through life and at the end (looking back) you have a singular history.  Therefore, when you were born there was but one not yet determined path that you would travel (out of many that you could have potentially travelled).  Now, after travelling whatever path you travelled through your life, there was only one of them that you actually travelled on a per-universe basis.  At birth, you have but one not yet determined future path per universe (out of many possible paths per universe).

 

The concept of the omniscient being is just an instructional aid.  You compared the instructional aid to predeterminism, and then threw it all out together under "predeterminism".  Perhaps somebody can help me correctly label what logical fallacy that is filed under.  Is it guilt by association, or red herring, straw man, or what?  Or a combo?

 

I'd be more charitable than to call it a logical fallacy - it's just a false premise.

[ERICOPOLY]

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

 

Pre-determinism is a straw man.  It is not a requirement for singular intrinsic value per universe.

 

I have mentioned that each universe has but one past.  And each will have but one eventual future.  Just because it will have but one eventual future does not mean that it is predetermined.  It's just the way things actually are.  You go through life and at the end (looking back) you have a singular history.  Therefore, when you were born there was but one not yet determined path that you would travel (out of many that you could have potentially travelled).  Now, after travelling whatever path you travelled through your life, there was only one of them that you actually travelled on a per-universe basis.  At birth, you have but one not yet determined future path per universe (out of many possible paths per universe).

 

The concept of the omniscient being is just an instructional aid.  You compared the instructional aid to predeterminism, and then threw it all out together under "predeterminism".  Perhaps somebody can help me correctly label what logical fallacy that is filed under.  Is it guilt by association, or red herring, straw man, or what?  Or a combo?

 

I'd be more charitable than to call it a logical fallacy - it's just a false premise.

 

Okay, I'm bad at coming up with the appropriate labels for these things.

[ERICOPOLY]

I see nothing special about day 1. Why wouldn't the IV change on day 2? Given an appropriate discount rate (separate discussion), present value is a function of time.

 

You've pointed out a nuance which I think is correct. It's a different point than Eric and I are trying to make, so I'm worried it will confuse the discussion.

 

If we stick with my 1 year note example- what we're trying to say is that from the perspective Day 1, the IV of the note is set in stone- because the future will only have 1 outcome.

 

What I think you're pointing out is that the IV calculation changes depending on which Day you look at the note. Clearly the NPV figure of the note is much higher if you're looking at it on Day 364-- its almost 100.

 

And you could say, Ah-HA! IV has changed! But then you've missed the whole point.

 

What we're saying is that if you're calculating the NPV of the note Day 1, there can only be one correct answer. Likewise- if you're calculating the NPV of the note on Day 364- there can be only one correct answer.

 

Yes it's basically this way by definition. 

 

"All the future" distributable cash flows discounted to "the present".

 

You can change "the present" and the calculation changes, because when you change "the present" from the current quanta to some future quanta, then recalculate it, the part about "all the future" has changed.

 

Logically, when you change the inputs to the equation you get a different answer.

[txitxo]

 

The theory is extensible to a multiverse, as I have pointed out.  There is one IV per universe.

 

You merely suggested that there is one IV per universe.  Exactly as I claim.

 

  Well, this is certainly the only place, in this particular Universe, where you can find a discussion of IV which touches on cosmology...:)

 

In principle each investor has a mathematical function which says IV = f(future cash flows, Assets,etc.). The big assumption on which all of value investing rests is that intrinsic value will tend to  the average market price.

 

Now, most of those inputs are known imprecisely. Some of them are intrinsically unknowable, in the sense that weather is unknowable a month from now even if you get the positions of all particles on earth and a computer big enough to calculate their interactions. Quantum fluctuations coupled with mathematical chaos will conspire to make the behaviour of the system impossible to predict. Even if you had that kind of information on all the possible multiverses and enough CPUs to crunch it, you would still be unable to exactly calculate the future. The very act of calculating it would spawn a much larger number of multiverses.

 

What you can do is calculate quite accurately the probabilities of different outcomes. You can know that that there is a 66% probability of the temperature being between T1 and T2, the humidity being between H1 and H2, etc.

 

  So a good, rational investor should first use an accurate version of the IV formula, then estimate the probability distribution for each of the inputs, and transfer that uncertainty into the value of IV. So you do not have a IV "value", what you actually have is a probability distribution, P(IV).  That P(IV) won't be a nice Gaussian, more likely an ugly looking beast, with asymmetrical tails.

 

  That's where the "margin of safety" enters. It is basically a rule of thumb to make sure that, for the typical width of a P(IV), your IV (and thus the expected average price of the share) is well enough above your purchase price.

 

  Now, great investors as Buffett (and you Eric, too) do all those calculations quite  accurately, without the need to make them explicit, using shortcuts and heuristics. The same as when a basketball player throws the ball, he is not integrating differential equations in his head.

 

  There are some simple cases, specially with small caps, in which you can design simple rules and algorithms to detect when IV is below market price and apply that as a mechanical investing system. For large companies things are much more complex, nobody knows how to code all the relevant factors explicitly, and people born with natural IV calculators in their brains have an advantage.

 

[ERICOPOLY]

  Now, great investors as Buffett (and you Eric, too)

 

I just have great Indian trackers (including those on this board) that point out the blood trail of IV leading into the bushes.  I don't myself know how to navigate the wilderness.  Buffett would be Kit Carson and I would be an ordinary person following behind. 

 

This works out just fine though. I retired 5.5 years ago after 10.5 years of work.  Today my RothIRA is equal to 60.75 years of my pre-tax salary on the day I quit.  It is 175.5 years of my pre-tax August 1997 starting salary.

 

That money comes entirely from what I was able to save in my 401k and IRA plans as a low-ranking employee of Microsoft -- all of it has since been rolled to the RothIRA.  Before Aug-1997, those accounts were empty (didn't exist).

 

 

[jay21]

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

 

Pre-determinism is a straw man.  It is not a requirement for singular intrinsic value per universe.

 

I have mentioned that each universe has but one past.  And each will have but one eventual future.  Just because it will have but one eventual future does not mean that it is predetermined.  It's just the way things actually are.  You go through life and at the end (looking back) you have a singular history.  Therefore, when you were born there was but one not yet determined path that you would travel (out of many that you could have potentially travelled).  Now, after travelling whatever path you travelled through your life, there was only one of them that you actually travelled on a per-universe basis.  At birth, you have but one not yet determined future path per universe (out of many possible paths per universe).

 

The concept of the omniscient being is just an instructional aid.  You compared the instructional aid to predeterminism, and then threw it all out together under "predeterminism".  Perhaps somebody can help me correctly label what logical fallacy that is filed under.  Is it guilt by association, or red herring, straw man, or what?  Or a combo?

 

Ok, so you are saying that time will pass and a set of cash flows will be experienced (I agree here).  And that those set of cash flows are what should have been used when determining the correct IV?

[ERICOPOLY]

Me:  Omniscience implies a fixed future.  The future is not fixed.  Therefore, the company's cash flows are not fixed and a singular IV cannot be determined.

 

Pre-determinism is a straw man.  It is not a requirement for singular intrinsic value per universe.

 

I have mentioned that each universe has but one past.  And each will have but one eventual future.  Just because it will have but one eventual future does not mean that it is predetermined.  It's just the way things actually are.  You go through life and at the end (looking back) you have a singular history.  Therefore, when you were born there was but one not yet determined path that you would travel (out of many that you could have potentially travelled).  Now, after travelling whatever path you travelled through your life, there was only one of them that you actually travelled on a per-universe basis.  At birth, you have but one not yet determined future path per universe (out of many possible paths per universe).

 

The concept of the omniscient being is just an instructional aid.  You compared the instructional aid to predeterminism, and then threw it all out together under "predeterminism".  Perhaps somebody can help me correctly label what logical fallacy that is filed under.  Is it guilt by association, or red herring, straw man, or what?  Or a combo?

 

Ok, so you are saying that time will pass and a set of cash flows will be experienced (I agree here).  And that those set of cash flows are what should have been used when determining the correct IV?

 

Yes.