We arrive at a valuation by estimating future cash flows discounted with a cost of opportunity rate of return: for a given level of acceptable risk, what are the sensible rate of returns available in the market?
- We consider the cost of opportunity that is currently available but we recognize that it is, to a certain extent, cyclical: it tends to vary according to fear and greed. We therefore remain cautious by defining a minimum required rate of return.
- The most stable and the simpler is a company’s business model, the easier it is to form an idea about its future. Understanding a business is about being comfortable about this business for the coming 10 years.
- We do not need to predict the future in order to understand that some basic human needs and features will persist in the future.
- It is easier to understand the future potential profitability of a company if it benefits from sustainable competitive advantages.
We allow for a margin of error, this is a margin of safety. The margin of safety aims to safeguard the investments against unidentifiable future unfavorable events, risks or mistakes.