if you're an investor whether you're investor in shares or an investor in perhaps an asset that's
going to throw off some revenue some cash flow into the future you're going to have to understand
and get your head around a concept called discounted cash flow or net present value
it's a method of valuing a future flow of cash or return on an investment warren buffett one of the
most successful investors of all time the guiding spirit along with charlie wanger of berkshire
hathaway says that the only way to value a share is with the discounted cash flow or net present
value method the starting point for understanding the valuation method is that 5 000 in a year's
time or 3 years time or five years time isn't worth as much to you as five thousand now
in other words money in the future isn't worth the same amount as money today in other words
it will have a different net present value what you need to do if you're looking at
investing in a machine or investing in shares you need to estimate as best you can the return
the cash returns let's just say for the sake of argument in shares the cash return on the shares
over the next five or ten years and then you discount those shares or the cash flow rather
to take into account two things one inflation in other words the five grand in three years time
is not as valuable or is not worth as much as five grand now in your hand and two risk in other words
you might get five grand in three years time or you might get a certain cash flow in three
years time or five years time but there's always a risk there's always a risk with any investment
so essentially what you do is you are looking at a share you will be able to look at previous
dividends that were paid on the particular share and then you're trying to extrapolate into the
future what the dividends are going to be what that return is going to be on your investment
in the share or shares over the next five or ten years you're going to apply down the
discount to take into account inflation and risk and that's going to give you a net present value
for the share price so if the share price is currently trading at say 15 euros
and you estimate then your cash flows based on historical dividend payouts
and historical cash flows and you estimate it then into the future
for five or ten years you're going to arrive at a net present value for that share and for
the sake of argument let's say it's trading today at 15 euros and the net present value is 13 euros
then it's clearly overpriced and not a good investment however if based on the future cash
flows by way of dividends you're going to get back over the next five or 10 years exceeds 15 euros
current share price in other words the net present value exceeds 15 euros
then it's a good investment it's a good buy and the discount factor that you're going to use
will vary depending on inflation will depend on the return that you might get on government bonds
and will depend on the risk attributable to the particular share so if you're buying a
share for example in a blue stock or a blue chip company or other then there is going to be a lower
risk of dividend failure over the next number of years as opposed to a more risky start-up stock
so that's essentially the basis of the discounted cash flow or net present value of
valuation and it is one as i say that warren buffet of berkshire hathaway swears by and
he says that is the way to value shares now online you're actually able to get
a discounted cash flow or net present value calculator you can actually get them online
or there's actually is a mathematical formula essentially because all you're doing is applying a
discount faction factor to a future stream of cash flow and that can be based obviously you need to
predict the future stream of cash flow and apply whatever discount factor but if you go to the
microsoft excel spreadsheet you'll find one of the formulas there is net present value or discounted
cash flow and likewise with the google sheets spreadsheet program it was originally invented
the method of valuation to look at capital investments by companies in for example
for example a machine let's say a machine is going to do a certain amount of work and
produce a certain amount of revenue over five or ten years and obviously it's going to depreciate
in value and eventually end up being scrapped but you can or a company could estimate fairly well
the potential return over the next say 10 years with the machine and then they're going to make an
assessment as it were evaluation of what they should be paying for that machine now what is
the true cost of it what is the net present value based on discounted cash flow into the future
anyway i hope you find this video useful if you have an interest in investing in shares
or property i have a course that i made it's an online video course you can check it out
i'll put a link in the description down below it's unteachable or you can have a look at my
website business and legal.i.e there's a page there which just explains about the
course there's 35 videos i think in it and half of them deal with property and half deal with
investing in shares and in the course i share what i've learned over the last uh 35 years i think
of investing in property and shares anyway i hope you find the video useful
if you do would appreciate if you give it the thumbs up down below thanks a lot