Thanks. It’s a great book. I actually listed it as one of my top 10 investing books of all time.

It is an amazon link, so I believe the affiliate referral pays out 4%…

When you’re done reading it, let me know what you think. I’m sure you’ll learn a lot. I still learn something every time I re-read it.

I absolutely agree with you that price and (economic) value are always subjective, never “intrinsic”. And it’s that discrepancy that can make or break you. The more you understand how to calculate the intrinsic value of assets, the better off you are. That’s what allowed me to be quite profitable during the dot com bust.

While I kept hearing everyone losing money, here I was quietly making money. I would even hear people talking about certain stocks saying that they had been so depressed that they should get back in, it could only go up. A stock that was $100 was now down to $1. What a deal! WRONG!!!

Just because it’s a $1, doesn’t mean it’s worth that. There was one company here that people were going nuts buying when it dropped to $1, just because it had been so depressed and couldn’t go down anymore. Of course they weren’t looking at the fundamentals. It could keep going down, and it did. While the company was selling at $1/share, it was also earning -$4/share. It was losing $4/share. Would you buy an asset for $1 that would be losing $4/year? That’s insane. And people thought it was a bargain!

On top of this, the company was running out of cash. At that point, if memory serves me right, it had less than 10 cents on the dollar in cash, and loads of debt. And no real assets. The intrinsic value was not $1. It was much lower. The brand name was worth something, but not $1. I predicted it had a lot further to fall, and it did. My prediction wasn’t on the success of the business, but on the price of the stock assuming it was still in business. And if it went bankrupt, than I wouldn’t get much, if anything at all. I believe it had more debt than cash reserves.

Anyways, to step off my soapbox, you’re absolutely right. The intrinsic value is much easier to calculate and is much less subjective. It’s still subjective but not to the same degree as price, since the businesses potential and speculation fever is often built into the price. The only subjective aspect of the intrinsic value is determining what your safety margin is. For example for me personally goodwill and intangibles (brand name value, etc.) are zero values. Factories and specific real estate assets are worth 10% (I wish GM, Ford, or Chrysler good luck in selling a car factory close to the price they paid, if at all). It’s much more concrete and easier to calculate. And Benjamin Graham and Warren Buffett have really illustrate just how easy it can be to estimate if you can separate yourself from the manic fevers.

Determining the intrinsic value is the harder part, and unfortunately it’s usually calculated a little differently by different people (depending on what you’re comfortable with). I’ve always personally looked at how Benjamin Graham and Warren Buffett calculated it, which is basically how much money does the asset bring you and how much could you sell it for today if it went bankrupt (ie there is no more business and you had to sell the assets at a firesale).

The hard part with this is that you can’t take into account potentials. Supply and demand do not really fit in as these are speculative. New markets and new businesses don’t fit in. By don’t fit in I mean you have to assign them zero values. That’s your safety margin.

So for example, with a business, if you calculate the total of all the assets (inventory sold off at 10%, property sold at fair market value, factories at 10%, etc.), cash on hand, etc. versus the debt, that gives you the asset price. That’s the intrinsic value. Therefore the closer the actual price is to the intrinsic value the better.

Of course it’s more complicated than that. For example with stocks a lot of companies pump up their brand value as a way of increasing their equity. There’s lots of tricks you can do: Why do Real Estate Investors Not Invest in Stocks the Same Way They do in Real Estate?

Surprisingly, and often enough, the intrinsic value of some assets will surpass their actual price. I remember buying stocks near the bottom of the dot com bust where the companies had more cash than the sale price of the company (the price of all the stocks combined), and they were consistently profitable!!! It was a great time and I made good money then. The dot com bust wasn’t all bad for everyone That’s actually what gave me the ability to start and finance my company LandlordMax.

A really good primer is the Intelligent Investor, especially the revised edition. Both are great, I own and have read both several times. Benjamin is great for determining the underlying value. Warren Buffett took Benjamin’s value calculations and added to them. He added elements into the calculation where a company that could build $2 in revenue from $1 was more interesting than one who could build $2 from $1.50. I’ve studied both of these greats and I’ve learned more than I ever realized possible.

As far as I can tell (from remote distance , in the UK situation there is another variable coming into play: even if they wanted to, it is a tough challenge for developers or private individuals to go ahead and start building further housing to meet the apparent demand, largely due to a massive “zoning / planning bureaucracy”. There are all kinds of councils having a say in what you can or can’t build (or in “listed” old buildings: repair/restore) and how much of it. Scares away lots of builders (result: demand cannot be met and prices fail to go down) and certainly drives up the costs of developers. Such a setting is indeed a fertile ground for “extreme speculation”. There’s probably more to it, but I’m always amazed how this particular aspect is never mentioned when UK house prices are discussed.

But it begs the obvious question – how do you work out the intrinsic value of a house? Although much of the UK rise in house prices is driven by speculation, there is also an element of supply and demand. Does supply and demand figure in the intrinsic value? Or is it just the build cost?

In the case of the .com boom how would one have worked out the intrinsic value of new businesses? These were new markets, new technologies and new business models (however flawed).