Trying to place a value on a business can be a complex and challenging process, especially if you want it to be complicated and challenging.
There are plenty of different ways to calculate intrinsic value, and depending on the level of detail you want to include in each method, some of these are much more rigorous than others.
However, even though he is possibly one of the most intelligent investors ever to have lived, Warren Buffett (Trades, Portfolio) likes to keep things simple when analyzing businesses.
Keep things simple
Rather than spending days computing complicated spreadsheets and reams of data, Buffett is looking for obvious value and a simple investment thesis that clearly shows a company's long-term potential and ability to increase intrinsic value.
In its purest form, Buffett's investment strategy is finding companies that are trading at a discount to their intrinsic value as based on a discount cash flow analysis.
As the Oracle of Omaha explained at the 1995 Berkshire Hathaway (BRK.A, Financial) (BRK.B, Financial) annual meeting of shareholders:
"We are trying to look at businesses in terms of what kind of cash can they produce, if we're buying all of them, or will they produce if we're buying part of them. And there's a difference. And then at what discount rate do we bring it back.
But there is no piece of paper. And we never — there never was a piece of paper that shows what our calculation on Helzberg's or See's Candy or The Buffalo News was, in that respect."
The fact that Buffett did not write down his evaluation methodology for these businesses is surprising, but it becomes less surprising when you understand what he is looking for.
The CEO of Berkshire is trying to find such obvious value that it does not require much effort or brainpower to determine.
"We really like the decision to be obvious enough to us that it doesn't require making a detailed calculation," Buffett declared to his audience in 1995.
He then handed the microphone over to his vice-chairman and right-hand man, Charlie Munger (Trades, Portfolio), who went on to add:
"Berkshire is being run the way Thomas Hunt Morgan, the great Nobel laureate, ran the biology department at Caltech. He banned the Friden calculator, which was the computer of that era. And people said, "How can you do this? Every place else in Caltech, we have Friden calculators going everywhere." And he said, "Well, we're picking up these great nuggets of gold just by organized common sense, and resources are short, and we're not going to resort to any damn placer mining as long as we can pick up these major aggregations of gold." That's the way Berkshire works. And I hope the placer mining era will never come. Somebody once subpoenaed our staffing papers on some acquisition. And of course, not only did we not have any staffing papers, we didn't have any staff."
The right approach
Considering the success the conglomerate has had over the years, this seems to be the right approach. It might make less sense if Buffett and his team were looking for complex businesses and did a lot of deals, but they are not.
As we have seen over the past few decades, the Oracle of Omaha is more than happy to sit on his hands for as long as it takes for the right opportunity to come along. As these opportunities are rare, he always has plenty of cash on hand to take advantage of them whenever they may arise.
Disclosure: The author owns shares in Berkshire Hathaway.
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