What Is a Stock Actually Worth?

Price is not value

Graham's first move was to pull apart two words most people use as if they mean the same thing. The market hands you a price. It never hands you the value. In the short run, he said, the market is a voting machine; in the long run it's a weighing machine. Price swings on mood and on who's buying and selling that day. Value sits underneath, in the business itself.

He made it concrete with Mr. Market: a moody partner who knocks every day with a new price, set by whatever mood he woke up in. He's there to serve you, not to advise you. Trade with him when his price suits you, ignore him when it doesn't. The one thing you can't let him do is tell you what your business is worth.

What intrinsic value actually is

The definition is simpler than most people expect. A business is worth the cash it will pay its owners over its life, counted in today's money. Buffett says it in one line: the discounted value of the cash that can be taken out of a business during its remaining life. Duan Yongping puts it plainer still: 'Buying a stock is buying the company, and buying the company is buying the discounted value of its future cash.' (2012)

So value isn't the share price, and it isn't the book value on the balance sheet. It's the cash the business will actually produce. Buffett liked Aesop's version of this: a bird in the hand is worth two in the bush. The whole job is counting the birds in the bush and judging how sure you are they're there.

That cash is in the future, so the value is never a hard fact. It's an estimate. Duan is blunt: 'intrinsic value is not calculated.' You don't solve for it with a formula. You make a rough, honest judgment about a business you understand.

The discount rate is your opportunity cost

'Discounted' is the word most people skip, and it's the one that carries the weight. In that 1999 Sun Valley talk, Buffett stripped investing down to a sentence: laying out money today to get more money back tomorrow. If that's the deal, a dollar the business earns ten years from now can't be worth a full dollar to you today. You'd rather have the dollar now and put it to work in the meantime. So you knock future cash down to reflect the wait, and how far you knock it down is the discount rate.

That rate is anything but a technicality. In the same talk, Buffett called interest rates the gravity of finance: 'interest rates act as gravity behaves in the physical world. At all times, in all markets, in all parts of the world, the tiniest change in rates changes the value of every financial asset.' A dollar arriving years from now is worth far less when rates are 13% than when they're 4%. Push rates up and every valuation gets pulled down; let them fall and everything floats higher.

Where does the rate come from? Duan gives the ground-level answer: it's really your opportunity cost, and the floor under it is the risk-free rate, something close to the yield on U.S. Treasuries. That's why the ten-year Treasury yield turns up under every serious valuation, including the value estimates on this site. It's the gravity the rest of your money gets weighed against.

You can only value what you understand

The four-concept version of value investing has a fourth leg that Graham didn't lean on and Buffett added from fifty years at it: the circle of competence. You can only estimate the future cash of a business you truly understand, and for most of us, most businesses sit outside that circle.

Li Lu's version cuts to the edge of it: 'a competence without a boundary isn't real competence.' A view you actually hold is one where you can name the conditions that would prove you wrong. Duan gives the working test. Understanding a company means you can roughly estimate its future cash, and the honest sign that you can is that you stop asking other people whether you understand it. What makes that cash estimable at all is the business model underneath it, and the culture running it. A durable business model, Duan says, is what keeps the future cash coming.

If you can't understand a business, you have no way to know what it's worth. So you leave it alone, even when the price looks cheap.

A range, not a number

Because the value is a guess about the future, it lands as a range, not a point. Two honest, careful people will come out with different numbers, and that's fine. Buffett's standard is to be roughly right instead of precisely wrong. Duan is blunter still: if you need a calculator to see that something's cheap, it isn't cheap enough. He calls his own approach a rough eyeball estimate, and he means it as a compliment. A detailed spreadsheet looks rigorous, but it lays a coat of false precision over what are still guesses about the future.

These investors mostly use the number for one thing: sizing up the downside, so they know what they'd lose if they're wrong. The real return comes from the judgment call: is this a good business, run by honest people, that will still be strong in ten years? That's the hard part, and no formula makes the call for you.

The golden rule: margin of safety

You've got a range for a business you understand, and you know the range can be wrong. That's the whole reason for the one rule you can't skip, Graham's margin of safety: buy far enough below your estimate that being wrong won't hurt you much. Pay right up to your estimate and you've left yourself no room to be human.

Li Lu reframes what you're really defending against. The risk that matters isn't the price bouncing around. It's the permanent loss of your capital, and the margin of safety is the wall you build against it. Duan takes it one step further, to a line worth sitting with: the margin of safety is really about the circle of competence, not just the price. A cheap price on a business you don't understand is no margin of safety at all. The safety comes from knowing what you own.

How this shows up on Compounder

This is the frame behind what you see on a stock page here. The value estimate shows up as a band, not a single target, because an honest estimate is a range. The margin-of-safety figure only appears when a stock sits genuinely below that band, since flashing a discount on a fairly priced stock would just be noise. And the ten-year Treasury yield sits under all of it as the discount anchor, because that's the opportunity cost everything gets measured against.

None of this tells you to buy or sell anything. It's the list of questions worth asking before you decide, and the deciding is yours.

Sources: Benjamin Graham, The Intelligent Investor; Warren Buffett, Berkshire Hathaway shareholder letters and "Mr. Buffett on the Stock Market" (Fortune, Nov. 22, 1999); Li Lu, lecture at Peking University (Oct. 23, 2015); Duan Yongping, published investment Q&A.