In our opinion the business value of any company is not derived from the momentum in its stock price or its last available trade but from the owners earnings of that business discounted by the appropriate rate.
When we value a business what we are considering are the earnings the business is able to generate now, and in the future, discounted by a risk-free rate of return.
If we could earn 6 per cent in a bank account or from lending our funds to the UK government at no risk, then the value of a company’s cash flows would be lower than in a period when could only earn 1 per cent for the same level of risk.
Accordingly, in our opinion the owners’ earnings from a business, its growth rate and the risk-free rate of return that we could earn by doing nothing are the factors that determine the true value of a business at any given time.
We favour businesses with a long term track record of increasing their owners’ earnings, and we think highly of companies with honest and capable management in industries we can understand.
We rarely buy into businesses in the early start up stages or with valuations well in excess of the long term growth rate. Some other investors do, and some turn a profit in doing so, but we have always found that conservative investors sleep well.