Here's What Warren Buffett Thinks Of Discounted Cash Flow Models (1995 Q21am)

Warren Buffett answers a question at the 1995 Berkshire Hathaway Annual Meeting on DCF models. The questioner is looking for the model or formula Buffett uses. But it's not that simple - yet it is straightforward - as Buffett explains.

#warrenbuffett #berkshirehathaway #discountedcashflow

[shankarbalakrishnan]

See u later cant multitasking right now out of fear im ok with the markets up or down I make something and can't focus but learning

[tplim]

Adam, how should a business owner think about his prospective return on invested capital in his investee companies?

Lets say he buys a simple, unlevered business that generates 10% normalised cash return on capital:
* Earnings $10 per share
* Tangible book $100 per share
* Capital structure is 100% equity

Am i right to say that his going-in return is 10% and will decrease to 7% pa over a 10 years holding period IF (a) the valuation does not change over the holding period, and (b1) management does not return capital to shareholders via buyback or (b2) distribute dividends to shareholders for them to reinvest?

If he buys the same business for $70, then his going-in return is 14% and will decrease to 9% pa (assuming no valuation re-rating) and 11% (assuming valuation re-rating).

It seems to me that the going-in yield will be the business owner's return if he could control how excess capital is re-allocated.

I would love to hear your thoughts on this.

[Value_Pilgrim]

Discount rates typically are calculated as i=ridlm (real rates + inflation + default rates + liquidity + maturity). One can probably use a rounding factor on top of gdp+inflation (CPI or WPI?)..

And as for cash stream probably some kind of normalized (+adjusted) EBIT I would assume.

Finally, I think they treat the business like a perpetuity.

At least that's been my takeaway so far. Am I even in the ballpark?