It’s Just Math: Intrinsic Value

One of the most fascinating aspects of investing is that the market often behaves as though arithmetic does not matter.

In the short run, stories, narratives, momentum, and speculation can dominate investor behavior. Stocks become popular not because they are valuable, but because they are rising. Likewise, stocks become unpopular not because they are worthless, but because they are falling.

The result is that markets periodically create enormous gaps between price and value.

These gaps are where exceptional investment opportunities emerge.

At The Oddsmaker, we spend a great deal of time thinking about intrinsic value. While the concept sounds complex, it is remarkably simple.

Intrinsic value is merely:

Everything else is commentary.

The challenge is not the mathematics. The challenge is estimating the future.

The market often treats investing as though it were a prediction contest. In reality, investing is a valuation exercise.

The objective is not to identify the company with the most exciting story.

The objective is to determine what future cash flows are worth today and compare that figure to the current market price.

When the gap becomes sufficiently large, opportunity exists.

Imagine a business that generates $100 of cash flow each year for six years and then sells for seven times its sixth-year cash flow.

The cash flows look like this:

Many investors make the mistake of adding these numbers together and concluding the business is worth $1,300.

But a dollar received six years from now is not worth a dollar today.

Time has value.

Risk has value.

Capital has a cost.

If an investor requires a 15% annual return, those future cash flows must be discounted accordingly.

At a 15% discount rate:

When we discount all future cash flows back to the present, the business is worth approximately:

This means an investor purchasing the business for $681 would earn roughly 15% annually if the cash flows materialize as expected.

The mathematics are straightforward.

The implications are profound.

Many investors spend endless hours debating earnings estimates while paying little attention to discount rates.

This is a mistake.

Small changes in discount rates create massive changes in value.

Consider the same business:

Notice what happened.

Nothing changed about the business.

The cash flows remained identical.

Only the required return changed.

Yet the estimated value declined by more than 50%.

This is why valuation is as much about risk as it is about growth.

The market is currently assigning extraordinarily different discount rates to different classes of assets.

Many high-growth companies are being valued as though risk barely exists.

Investors are willing to capitalize distant future profits at remarkably low discount rates.

In some cases, companies generating minimal current earnings trade at:

Investors are effectively saying:

Perhaps they are correct.

Perhaps they are not.

The challenge is that these businesses are often extraordinarily difficult to value.

A small change in assumptions can dramatically alter intrinsic value.

When most of the value lies ten or fifteen years into the future, forecasting becomes increasingly speculative.

In contrast, there are businesses today with:

that trade at valuations implying little or no future growth.

These businesses may not be exciting.

They may not dominate financial headlines.

They may not be discussed on social media.

But they are often far easier to value.

Why?

Because much of their value comes from cash flows investors can see and measure today.

The future does not need to be extraordinary.

It merely needs to be less pessimistic than the market currently assumes.

One of the most misunderstood drivers of investment returns is multiple expansion.

Investors often focus exclusively on earnings growth.

But a company does not need to grow rapidly to generate exceptional returns.

Consider a business trading at:

If investor sentiment normalizes, the stock may appreciate substantially even if the underlying business simply performs adequately.

In these situations, investors can benefit from:

Many more good things can happen than bad things.

The odds become asymmetric.

This is precisely the type of setup we seek.

Benjamin Graham famously observed that:

The voting machine measures popularity.

The weighing machine measures value.

Today, many investors are voting enthusiastically for a relatively small number of fashionable narratives.

At the same time, many profitable, cash-generative, underfollowed businesses continue to trade at substantial discounts to intrinsic value.

This is not unusual.

It has occurred repeatedly throughout market history.

The names change.

Human behavior does not.

We do not attempt to predict which story will be most popular next month.

We do not attempt to forecast which narrative will dominate financial television.

Instead, we focus on a simpler question:

If the answer is materially above the current stock price, we become interested.

If the answer is materially below the current stock price, we become cautious.

Over time, the arithmetic tends to win.

Not immediately.

Not perfectly.

But eventually.

The greatest opportunities often emerge when investors become so focused on what is exciting that they forget what is valuable.

That is when price and value diverge.

And that is when investing becomes most interesting.

In the end, investing is not magic.

It is not storytelling.

It is not momentum.

It is not speculation.

It is simply the discipline of paying less for an asset than it is worth.

The complexity in the market is that high growth companies may or may not have much value, especially at 100x sales and low discount rates. These are complex hard to value assets. What is much easier to calculate is very low expectations with very strong balance sheets and profitable businesses. Many more good things than bad things can occur with many of our setups: mainly multiple expansion to catch up to the rest of public equity.