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Buffett On Discount Rates: How To Apply His Methodology Today

Dec. 06, 2018 8:02 AM ETAAPL, AMZN, BRK.A, BRK.B9 Comments
Billy Duberstein profile picture
Billy Duberstein


  • Warren Buffett values stocks based on the present value of free cash flows, like all sensible value investors.
  • However, his attitude towards discount rates is very unique.
  • Concentration/conviction vs. diversification appear to require different techniques, even if both types of investors use DCF analysis.
  • Looking for more? I update all of my investing ideas and strategies to members of Fat Pitch Expedition. Start your free trial today »

As a therapeutic exercise during this crazy quarter, I have been re-watching old Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) annual meeting videos, which are now available (from 1994-onwards) on both YouTube and CNBC.

With all of the hullabaloo about rising rates and equity risk premiums in the current environment, I came across an interesting snippet from the 1996 annual meeting regarding discount rates. Like all sensible value investors, Buffett values stocks based on the present value of all future cash flows, and then buys at significant discount.

But Buffett does in fact think about the inputs differently than the "traditional" capital asset pricing model (CAPM). The curious thing about how Buffett values stocks is that, unlike most traders, he uses a risk-free rate (or close to it) to discount a company’s future cash flows (with a small premium in an era of extraordinarily low interest rates – like we have now).

From the meeting:

“We basically think in terms of the long-term government rate.

And there may be times, when in a very — because we don’t think we’re any good at predicting interest rates, but probably in times of very — what would seem like very low rates — we might use a little higher rate.

But we don’t put the risk factor in, per se, because essentially, the purity of the idea is that you’re discounting future cash. And it doesn’t make any difference whether cash comes from a risky business or a safe business — so-called safe business. So, the value of the cash delivered by a water company, which is going to be around for a hundred years, is not different than the value of the cash derived from some high-tech company, if any, that — (laughter) — you might be looking at.

It may be harder for

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This article was written by

Billy Duberstein profile picture
I am a California-based financial advisor and run a concentrated, long-biased equity strategy. NYU Stern MBA, former student of Damodaran and Galloway, among others. A love of the dramatic arts/narrrative, sports, and music all inform my investing philosophy. I have written and appeared on several investment publications such as The Motley Fool, Barrons, and Cheddar TV. My tastes run the gamut of investing approaches (value, GARP, and high-growth disruptors) that I like to characterize as "Special Companies" and "Special Situations" -- any unique bottoms-up opportunity that has  outsized risk/reward characteristics.

Analyst’s Disclosure: I am/we are long AAPL, AMZN. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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