In one sentence: Phil recaps four valuation methods and works through the first two on the lemonade stand: the 10 cap ($8 free cash flow gives about $80 a share) and the margin-of-safety analysis ($11 of earnings growing 13% gives a $186 sticker price and a $93 buy price).
Key ideas
- Simple but not easy. Munger's four filters are simple, but they take patience: "not doing stuff most of the time". Reading about companies 15 minutes a week or 15 hours is a practice with no finish line. [00:00–04:30]
- The snowball. Knowledge accumulates, and so does money through compounding. Compounding also works against you through debt. [04:30–06:30]
- Cash beats a bad purchase. Buffett's two rules: don't lose money, and don't forget rule one. Losing 50% takes a 100% gain to recover. [07:00–09:30]
- Expensive markets are normal. If everything is fully priced, finding a bargain is hard. Phil says bonds paid almost nothing and pushed money into stocks. This is his 2016 view, not a forecast. [09:30–12:30]
- Four ways to value, and only two covered today. The aim is to value easy businesses four ways, not to be a valuation expert. [13:00–15:00]
- 10 cap. Decide you need a 10% return on free cash flow. $8 per share ÷ 10% = $80. It suits a well-run growing business because growth works like rent increases on a fixed-up building. It is a very high bar, so a business you like goes on the watch list until Mr. Market lowers the price. [14:30–20:30]
- Sticker price in four numbers. (1) Latest earnings, normalised for short-term oddities ($11). (2) A long-term growth rate, which is a judgement from sales, book value, earnings and cash growth (13%). (3) A future PE (20). (4) The return you require (15%). [20:30–25:00]
- Check growth against market size. If Apple grew 26% for years, earnings would double every three years, which cannot go on. Yahoo's price once implied absurd revenue. [22:00–24:30]
- The arithmetic. $11 grown at 13% for 10 years is about $37. At a 20 PE that is about $746. Discounting at 15% a year means dividing by 4, so the sticker price is about $186. Windage means rough numbers are fine. [25:00–29:30]
- Margin of safety. Cut the sticker price in half: $93. The earlier rounded version gave $100, and Phil says a 7% gap doesn't matter. Beginners should insist on their number. Buffett now buys at 20–40% below sticker, not 50%. [30:00–35:00]
- Technology is hard to value. Industries that must replace their own products are risky to predict, so look for a moat beyond the technology. [35:00–36:30]
- Two answers differ. 10 cap says $80, margin of safety says $93 to $100. As more methods agree, confidence grows. [36:30–38:30]
How it maps to RuleOne
- The stock pages show a sticker price and margin-of-safety price built the same way: earnings, growth, future PE and a 15% required return. Compare their inputs with Phil's.
- The 10 cap is the inverse of a price-to-free-cash-flow multiple of 10. A stock with a P/FCF under 10 passes this test.
- The growth input is where the judgement is. Look at the stock page's growth history for sales, book value, earnings and free cash flow, and pick a number you can defend.
Buffett, Munger and Graham links
- Buffett's "Rule No. 1: never lose money" appears in his 1980s shareholder remarks. Phil quotes it as two rules.
- Margin of safety is Graham's central idea (The Intelligent Investor, ch. 20).
- IBM is Phil's example of a tech company with a switching-cost moat. Buffett bought it (2011) and later admitted a possible mistake. Phil is not recommending it.
- Phil attributes the "the market is wrong more often than you think" line to Prem Watsa. Treat it as an unverified paraphrase.
Words to know
- Sticker price: intrinsic value in 10 years, discounted back at the return you require.
- Windage: Danielle's word for rough numbers, as a shooter allows for wind.
- Compounding: earning returns on prior returns.
Try this
Open any stock on /stocks/ and compute $8 ÷ 10% for it: take the latest free cash flow per share, divide by 0.10, and compare that price with today's. Then compare with the site's margin-of-safety price.
Check yourself
- What four numbers make up the sticker price?
Answer
Normalised earnings, a long-term growth rate, a future PE, and the required annual return (15%). - What are the 10 cap price and the margin-of-safety price for the stand?
Answer
About $80 and $93 (the sticker price of $186 cut in half). - Why do beginners insist on an exact price?
Answer
It builds discipline and avoids talking yourself into a deal. Experienced investors can be looser where they know the moat.
Short quotes
"We are going to cut the price in half and give ourselves an enormous margin of safety." (Phil, ~31:00, auto-transcribed)