Book Value and Intrinsic Value

 

Traditional Accounting

Clean Surplus Accounting

 

 

ROE = Earning/Book Value

 

ROE = Net Income/ Owners’ Equity

 Where,

Where,

               Revenues

minus all operating expenses including depreciation, interest and taxes

               Revenues

minus all operating expenses including depreciation, interest and taxes

             =Net Income

Minus non recurring items such as extraordinary loses (or gain) and future liabilities

               =Net Income

             =Earnings

 

 

 

And Book Value is =

And Owners’ Equity =

Common Stock + all Retained Earnings

Common Stock + all Retained Earnings

Where,

Where,

This Retained Earnings = Earning - Dividends

This Retained Earning = Net Income -Dividends

Or,

 

Book Value = Assets – Liabilities = Owners’ Equity

 

 

Often we understand,

  Book Value = Net Asset Value = Tangible Asset Value = Balance Sheet Value = Net Worth = Owners’ Equity

But they are not exactly the same.

 

 

Intrinsic Value

Warren Buffett stated the following:

 

Intrinsic value is the discounted value of the cash that can be taken out of a business during its remaining life.[224, The essays of Warren Buffett, 3rd edition]

 

Calculations of intrinsic value are necessarily imprecise and often seriously wrong. The more uncertain the future of a business, the more possibility there is that the calculation will be wildly off-base. [228]

 

          Intrinsic value is an estimate rather than a precise figure, and it is additionally an estimate that must be changed if interest rates move or forecasts of future cash flows are revised. Two people looking at the same set of facts, moreover---and this would apply even to Charlie and me----will almost inevitably come up with at least slightly different intrinsic value figures. [224]

 

Buffett also gave shareholders an easy-to-understand tutorial on how a company’s intrinsic value could exceed its book value by the magic of economic goodwill. [“The Warren Buffett Way.” 3rd Edition ]

         That is: Intrinsic Value = Book Value + Economic Goodwill

                                         = [1 + x] Book Value

 

OR

Intrinsic Value = Book Value + Economic Goodwill

                                           = Quantitative value + Qualitative Value

 Where,

   Quantitative Value can be calculated from The Balance Sheet and Income Statement and

   Qualitative Values are estimated from:

                                Franchise

                                Monopoly

                                Toll Bridge,

                                 Moat

                                 Pricing ease

                                 Goodwill

                                 Durable Competitive Advantage

                                 Honest and Competent Management