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104 - Terminal Value and Why Intrinsic Value grows over time

The DIY Investing Podcast

Release Date: 12/07/2020

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More Episodes

Mental Models discussed in this podcast:

  • Terminal Value 
  • Intrinsic Value 
  • True Historic Value 
  • Discounted Cash Flow Calculation 
  • Net Present Value 
  • Fog of War 

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Show Outline

The full show notes for this episode are available at https://www.diyinvesting.org/Episode104

Why does Intrinsic Value grow over time?

There are multiple ways to answer this question. 

  1. It doesn't. Intrinsic value is fixed, but your estimate of intrinsic value will change. 
  2. Your assumptions were wrong because you made a mistake. 
  3. Your assumptions were wrong because you can now see more of the future.
  4. A year moved from being inside Terminal Value to inside your forecast range. 

What is Terminal Value?

  • How is it calculated?
  • Why does it matter?
  • Terminal Value is the net present value of all future cash flows discounted back to a specific year in the future. (Perhaps 5 or 10 years from now)
    • In other words, Terminal Value is your estimate of the Intrinsic Value of a stock 10 years from now.
  • As each year passes, the "fog of war" that is the future becomes illuminated. That means that we can now *SEE* the future.
  • Concept: True Historic Value 

Summary:

Terminal Value is the net present value of all future cash flows discounted back to a specific year in the future. Intrinsic value is fixed, but your estimate of intrinsic value will change over time.
In addition, you can evaluate how the intrinsic value of a company has changed over time in the past by calculating the True Historic Value. This value is the intrinsic value at a past date assuming 10% future annualized returns all the way to the present.