Warren has only one way in which he assesses the value of an asset (be it shares, businesses or other).
He starts with the saying: A bird in the hand is worth two in the bush.
To flesh out this principle, you must answer only three questions.
- How certain are you that there are indeed birds in the bush? (probability of success)
- When will they emerge and how many will there be? (timing and quantity)
- What is the risk-free interest rate (which we consider to be the yield on long-term U.S. bonds)? (opportunity cost of capital)
We should adopt this mindset when valuing opportunities.
Example: Should we spend time trying to master franchise overseas?
- Probability of success: very low
- Timing and quantity
- Timing of outcomes: Small upfront, rest over two years
- Quant ity of outcomes: Medium (~100k net of all initial fees?)
- Opportunity cost: time on Poked, improving margins at Poked or Scroll, new business opportunities
At the present moment, the master franchise opportunity should not be pursued.
In order to make it more attractive, it’s very clear what needs to be done. There are three levers:
- Increase the probability of success
- Position more cash flows upfront
- Increase the size of the pie (e.g. more countries/bigger master franchisor)
The formula in your head should be:
Probability of Success x Profit Outcome if Successful = Value
E.g. 10% chance of master franchise x 100,000 benefit = $10,000 of value
Assess every opportunity with that approach and then rank them based on value.
You should then be able to decipher where your time, capital and energy should be devoted.