Warren Buffett has a unique approach to stock investing that has allowed him to be one of the most successful investors of all time. Put simply, Buffett’s strategy is to buy businesses at prices below their intrinsic value.
How does the Berkshire Hathaway CEO assess intrinsic value? According to Buffett himself:
If you attempt to assess intrinsic value, it all relates to cash flows. The only reason for putting cash into any kind of investment now is because you expect to take cash out. Not by selling it to someone else, because that’s just a game of who beats who, but by, in a sense, what the asset itself produces. That’s true if you’re buying a farm, it’s trut if you’re buying a business.
As Buffett sees it, the intrinsic value of a business has nothing to do with what its share price will be in the future. Instead, it is solely a function of the cash the business will produce.
Earnings
Take Apple (NASDAQ:AAPL) as an example. The company produced $6.05 in earnings per share this year and this is forecast to rise to $6.90 by 2024.
For Buffett, the intrinsic value of Apple shares has nothing to do with what its share price will be in 2024, or what its price-to-earnings (P/E) ratio will be. Rather, it is just a matter of how much the company makes.
Right now, Apple stock trades at $157. According to Buffett, if the company produces $6.90 in 2024, then the return for an investor who buys shares today will be 4.39% in that year.
Importantly, it has nothing to do with whether the share price will be $140, $160, or $190. That, for Buffett, is a game of who beats who, not investing.
A stock I’m buying
Put simply, Buffett attempts to calculate the intrinsic value of a business by comparing the cash it will generate in the future to its current price. When I do this, there’s a stock that clearly stands out to me as a bargain right now.
That stock is Meta Platforms (NASDAQ:META). It’s a stock I own in my portfolio and I think that its shares are undervalued at the moment.
At the moment, the risk to the company is its Reality Labs segment. Last year, Meta spent around $10bn on its metaverse business and it will be some time before that investment is expected to pay off.
In my view, however, the current share price more than justifies the risk. Despite its significant metaverse spend, the company generated $35bn in free cash last year.
What does that mean by Buffett’s standards? It’s a return of around 8%, which I think is attractive with interest rates solidly below 3%.
The price for the entire business is currently just under $438bn. But the company also has $16.6bn in cash and $13.9bn in debt.
That gives a value for the whole business of around $435bn. Against this, an annual return of $35bn looks strong to me.
The share price might go anywhere, but that’s not how Warren Buffett thinks about his investment returns. Despite its significant capital expenditures, Meta Platforms generates huge amounts of cash, which is why I’m buying shares at these prices.
