Investing and stewardship go hand-in-hand.
The true understanding of investing is laying out cash now, in order to get more later. You can also view investing as allocating your capital in such a way that produces the most in return.
A farmer is going to plant seeds today, in order to reap the fruit tomorrow. An arborist will plant a tree today, in order to provide shade for someone and a home for many birds and squirrles 25 years from now. A steward is one who trades with what he has been entrusted with in order to provide a sizable return for his master. (Matt 25:16).
However, there is a kind of investing that isn’t valuable: I will refer to that as speculating. In the case of speculating, we can view it as someone who buys a business, a house, a farm, an apartment with the assumption that the next guy will pay more for it without increasing its intrinsic value. This is like bluffing while playing poker: it can in the short run, but will bite you hard in the long game.
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Let’s pretend you have a friend named Bob. Bob comes to you everyday, sometimes a few times a day, and offers you to purchase a wallet. But this isn’t any ordinary wallet. Every year, $100 appears in this wallet. Bob wants you to buy this wallet and so he comes to you every day and gives you a purchase price.
How do you know what to pay? Would you pay $1M? $100K? $10K? $1K? How much is this wallet worth? What is the intrinsic value of this wallet?
Sometimes Bob comes to you in an extremely giddy mood doing backflips while offering you an outrageously high price because of his excitement! Other times he comes to you crawling out of depression and sadness. He desperately offers you a price at an overwhelmingly low price. Bob is bi-polar. Bob is emotional. Bob is sentimental.
How do you know how much to pay? The only way you’ll know is if you have a price in your mind before Bob quotes you a price. So then the question is, how do I determine a price?
What is Intrinsic Value?
The word “intrinsic” is an adjective. It’s a describing word that means “belonging to a thing by its very nature.” The question you must answer is “what is the intrinsic value of this wallet?”
That is something that can get a little more hazy. The main reason is because people will put a different value on the same thing. One guy is willing to pay $2 for an apple, another guy is only willing to pay $1. Same goes with the wallet example. You may value the wallet at $1000 and I may value it at $500. Who is right? Well that depends.
The basic way to find intrinsic value is to discount all the future cashflows of the business to the present: that is your intrinsic value. When the price is lower than the intrinsic value, than you’re potentially purchasing a bargain.
Margin of Safety
Apart from determining you intrinsic value, you must account for human misjudgment and other potential errors that may cause you to loose money. That is why we must always include a margin for error, or what Benjamin Graham calls a “Margin of Safety.” What that is, is simply a buffer. It’s a cushion. It’s insurance. It’s minimizing your risk.
The concepts of "Bob" has been adopted from The Intelligent Investor by Benjamin Graham. He uses the term "Mr. Market."