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Warren Buffett Brilliantly Explains Discounted Cash Flow - YouTube
Channel: FREENVESTING
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the gentleman from australia asked about
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margin of safety
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and you replied that a superior business
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may not require that much of a margin of
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safety
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i'm very curious how you come up with
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your discount rate
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and how you might adjust that discount
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rate based upon
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various businesses
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we don't formally have discount rates i
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mean every time i
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start talking about all this stuff
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charlie reminds me that i've never
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prepared a spreadsheet but i do
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you know in effect in my mind i do but
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uh
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we are going to want
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to get a significantly higher return
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obviously
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in terms of cash produced relative to
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the amount we're outlaying now
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for a business than we are from a
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government bond i mean we
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you know we're gonna that that has to be
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the yardstick at a base
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then how much more do we want well
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if government bond rates were two
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percent we're not going to buy a
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business to earn three or three and a
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half percent
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expectancy over the years we just don't
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want to commit our money that way we'd
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rather sit around and wait a little
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while
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uh if they're four and three quarters
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percent you know
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what do we hope to get over time well we
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want to get a fair amount more than that
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but i can't
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i can't tell you that we sit down every
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morning and and i call charlie in los
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angeles and say what's our hurdle rate
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today i mean
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we have never used the term uh
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you know it's a little bit of the the we
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want enough so that we feel very
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comfortable
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if they close on the stock market for a
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couple of years if interest rates go up
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another 100
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basis points or 200 basis points we're
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still happy with what we bought
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and above that i really you know i know
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it sounds kind of fuzzy but it is fuzzy
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charlie yeah the concept of a hurdle
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rate
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makes nothing but sense and yet a lot of
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terrible errors are made by people who
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are talking
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about hurdle rates
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just because you can measure something
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and guess it doesn't mean that it's the
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controlling variable and what you're
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dealing with in a messy world
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and uh i don't think there's any
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substitute for
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thinking of hope about a whole lot of
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investment options and
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thinking about why one is better than
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another and what the likely returns are
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from each etc etc and
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the trouble with a hurdle rate concept
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not that we don't have one in a sense
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uh is it doesn't work as well as
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as a system of comparing things
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in other words if if i have something
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available
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that i think will give me eight percent
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for sure
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and i can buy all i want of it and
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you've got a perfectly good investment
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that
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i think will earn seven i don't have to
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waste five minutes with you
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you're like the mail order service
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offering the bride through the mail and
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she's got aids you know i can go on to
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some different subject
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and and it's and so this
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the concept of opportunity cost is
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it's so little taught in investment they
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teach it in the freshman course in
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economics and all the major universities
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but when you get to the corporate
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finance departments and so forth
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it doesn't lend itself to the kind of
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mathematics they want to use so they
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ignore it
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but in the real world your opportunity
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costs are what you want to make your
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decisions based on
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yeah and even if you were if you had
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something you were really familiar with
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and were very sure on the eight percent
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eight and a half wouldn't tempt you if
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somebody came along that's the practical
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matter
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it i've been on as i mentioned i've been
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on 19 corporate boards
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i would say that of the presentations
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i've seen
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and i've seen a lot of them and every
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one of them had a calculation of
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internal rate of return
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you know if they'd burned them all the
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boards would have been better off i mean
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it
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it there's so much nonsense presented
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because
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the presenters essentially know
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what the listeners or desires of hearing
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and what is needed in order to get
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through something that the ceo wants to
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do
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anyway that you just it's just you just
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get nonsense figures
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and uh you know we may get nonsense
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figures too but they're ours
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let me give you an example of that i
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have a young friend
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who sells private partnership interests
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to
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investors and he's in a really tough
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field where it's hard to get decent
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returns
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and i said what return do you tell him
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you're aiming for and he said 20
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and he said how did you pick that number
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he said if i
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chose any lower number they wouldn't
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give me the money
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and there's no one in the world we think
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can earn 20 with big money
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i mean it just so anybody making a
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promise like that
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basically we we're going to write off
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immediately uh
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uh it's amazing to me
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what you know in a sense how gullible
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big investors are pension funds and so
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on and that they
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they have people come around and promise
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them the holy grail and they want it so
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badly
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you know that they're willing to believe
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things that just have to be nonsense
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you
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