The world's first investment primer was issued by the Greek fabulist and storyteller Aesop -- that's what Warren Buffett (Trades, Portfolio) believes anyway.
As Buffett said at the 2000 Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial) annual meeting: "The first investment primer that I know of, and it was pretty good advice, was delivered in about 600 B.C. by Aesop. And Aesop, you’ll remember, said, 'A bird in the hand is worth two in the bush.'"
I don't believe this was the first time Buffett referenced Aesop's work, and it certainly wasn't the last.
Buffett has referred to Aesop many times over the years, and it easy to see why. Indeed, while this quote might seem simple and easy to understand, there's plenty more going on underneath that investors might miss at first glance.
As Buffett explained in 2000, Aesop's quote is missing the answers to some other key questions that go along with it, namely "exactly when" the two birds are going to come out of the business and "what interest rates were that you had to measure this against."
Buffett goes on to say that if Aesop had laid out these factors, "he would have defined investment for the next 2,600 years." The Oracle of Omaha went on to say:
"And then the question is, as an investment decision, you have to evaluate how many birds are in the bush. You may think there are two birds in the bush, or three birds in the bush, and you have to decide when they’re going to come out, and when you’re going to acquire them.
Now, if interest rates are five percent, and you’re going to get two birds from the bush in five years, we’ll say, versus one now, two birds in the bush are much better than a bird in the hand now.
So you want to trade your bird in the hand and say, “I’ll take two birds in the bush,” because if you’re going to get them in five years, that’s roughly 14% compounded annually and interest rates are only five percent.
But if interest rates were 20%, you would decline to take two birds in the bush five years from now. You would say that’s not good enough, because at 20%, if I just keep this bird in my hand and compound it, I’ll have more birds than two birds in the bush in five years."
"That's all investing is," Buffett summarized. Investing is all about making a buy or sell decision based on the projected value of a business. Value is calculated by estimating how many birds are in the bush (or how much cash the business can generate), when they are going to emerge and what interest rates are.
When you have the answers to these three questions, you can make an informed guess of intrinsic value and whether or not the business in question is undervalued.
Later in the discussion, Buffett said that when he evaluates a business, he always looks at the company's market value -- even if he's only buying a small stake -- and then considers the return on that value. He wondered out loud if any other investors bother to do the same thing:
"And I question, in my mind, whether —sometimes, whether people who pay $500 billion implicitly for a business by buying 10 shares of stock at some price, are really thinking of the mathematical —the mathematics —implicit in what they are doing."
Buffett then gave an example: if you want a 10% per annum return, a $500 billion company would have to generate $55 billion a year in perpetuity. He went on to say investors will not find any companies that can create this return.
That might not be so obvious if you're looking at a company in terms of its stock price, but it is incredibly apparent when you take a step back and look at the total market cap.
Disclosure: The author owns shares of Berkshire Hathaway.
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