Say Yes-Yes to Net-Nets
The core principal of value investing is to make investments that carry a satisfactory margin of safety. Simply defined, a margin of safety is the difference between the intrinsic value of the business and the price you pay. The bigger the gap, the higher the margin of safety. Analyzing a business always requires making assumptions about the future, thus, there's an element of uncertainty. The margin of safety helps protect against those uncertainties.
Various methods can be used to derive intrinsic value. The most useful entails forecasting future free cash flows, discounting by an appropriate rate to derive their present value and then taking the sum of those present values and a terminal value. Another simple metric is price-to-book ratio. A business that can be bought below book value is often viewed as selling below intrinsic value. Yet the PB ratio requires a high degree of confidence that the assets are indeed worth book value, but that's a topic for another discussion....427 more words left in this article. To read them, just click below and try Real Money FREE for 14 days.
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