Many of the investment opportunities we have identified over time have been created by the fact that the market appears to value companies based principally on short-term factors rather than long-term changes in intrinsic value. For example, in light of China weakness, commodity price declines, and the events in the U.S. energy markets, current earnings and future expectations for railroad volumes have declined somewhat. We believe that this has reduced Canadian Pacific (CP, Financial)’s intrinsic value by perhaps 10% or so while its stock price has declined ~35% from its August 2015 high. The value of a business is determined by the present value of the cash it generates over its lifetime, not based on what next year’s earnings are going to be. While the first year’s cash flows in a discounted cash flow valuation carry the most weight in the calculation, years two through 20 and thereafter contribute many multiples of year one’s value in determining the present value. This fact seems to be ignored by investors in today’s markets. The market’s short-term valuation approach coupled with the technical factors present in non-index supported companies can lead to short-term gross under-valuations and new long-term investment opportunities.
From Bill Ackman (Trades, Portfolio)'s Pershing Square Annual Investor Letter 2015.
