Tackling the 'forecaster' in you
You've identified a strong Indian 'franchise' and you've performed DCF on it. Your DCF based valuation gives you a valuation that is 10 per cent higher than the current market price. Sensing opportunity, you are ready to take the plunge aren't you?
Yes, if you believe you are the perfect 'forecaster' of a firm's cash flows. However, Buffett thinks that he is not and, hence, he relies on a concept called as 'Margin of Safety' (MOS). What is this MOS? Let us hear in his own words.
He says: "We insist on a margin of safety in our purchase price. If we calculate the value of a common stock to be only slightly higher than its price, we're not interested in buying. We believe this margin-of-safety principle, so strongly emphasized by Ben Graham, to be the cornerstone of investment success."
When you buy, please ensure that your DCF-based value per share is at least 50 per cent higher than the current share price so that even if your assumptions turn out to be little aggressive or something unexpected happens to the company, the loss of your initial invested amount is minimized.
Image: The bronze bull , recently installed outside the Bombay Stock Exchange. | Photograph: Pal Pillai/AFP/Getty Images
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