Warren Buffet’s take on the oldest Investment Advise delivered by Aesop in 600 B.C.
Every time we want to analyze the value of a business and decide if it is worth investing in, we can refer to a classic lecture given by Warren Buffet during one of Berkshire Hathaway’s annual meetings.
Buffet states that once we know the cash flow of a business between now and judgement day, we have a precise figure of what it is worth today. For him, it is clearly a value decision based on the expected growth of the business. To clarify the concept, he quotes the oldest investment advise delivered by Aesop in 600 B.C.: “a bird in the hand is worth 2 in the bush”.
It is indeed an investment equation. It implies that what we hold today should value more in the future. But Aesop’s equation missed to account for two additional factors:
- When are we going to get the 2 birds?
- What is the current (risk-free) interest rate
In fact, If we are ready to trade one bird in the hand (our cash), as an Investment decision, we need to evaluate how many birds are in the bush, when and if we can realistically acquire them. In doing that, we will also look at other birds and other bushes.
Buffett highlights 2 examples:
a) If the interest rate is 5% and we are going to get 2 birds in 5 years (vs 1 now), 2 birds are a better deal (14% compound annually).
b) On the other hand, if the interest rates are 20%, and we are still going to get 2 birds in 5 years, we should decline the deal because by keeping our bird in the hand, we would already have an annual interest rate of 20%. Compounded annually, it will become more than two birds in the bush in 5 years.
The more we have to wait to take the bird out of the bush, the more birds we should be able to take to justify the equation. The equation outlined by Aesop is immutable: it can be applied today for evaluating any asset, from stock to bonds, from farms to businesses. Buffett suggests to work out what cashflows we – as investors – are going to receive from the asset we own and/or plan to buy. As investors, we need to get the implicit math right whenever we invest, clarify when we expect the return to arrive, make conservative forecasts, and use an appropriate interest rate to compare the returns against other alternatives.
2000 Berkshire Hathaway annual meeting. You can watch Buffet’s full analysis here.