[Investment Philosophy] An Article to Understand the Essence of Value Investing
I have recently been reading Duan Yongping's book, which has deepened my understanding of value investing. I originally intended to share this on another platform, but I have summarized it here to share with everyone, mainly for those who want to understand.Value investing的moo友，这种投资方式也是过去我在【Investment PhilosophyThis is one of the more recommended articles in the series, but I want to emphasize one point here.Friends who focus on swing trading and trading systems can skip this article, as the cognitive frameworks are different and the discussion is not very meaningful. The more we talk, the easier it is to deepen misunderstandings. However, it is always good to learn more investment methods and find those that suit one's personality.
More precisely, value investing focuses on how a company makes money and whether it can continue to do so; market sentiment is often just noise and opportunity. In contrast, swing trading is more about predicting what others will think, with market sentiment becoming a source of profit. For example, gold itself does not generate cash flow—trading gold essentially involves speculating on the market's expectations for gold prices.
"Buying stocks is essentially buying companies, and buying companies means buying the discounted future cash flow." Understanding a company means understanding its moat, which is the value investing philosophy consistently emphasized by Buffett and Duan Yongping. $Berkshire Hathaway-A (BRK.A.US)$ $Berkshire Hathaway-B (BRK.B.US)$Whether the stock price is currently expensive or cheap ultimately depends on the judgment of future cash flows (as outlined in the mathematical formulas below) when returning to first principles.
On the premise of understanding a company's moat, the assessment of a long-term sustainable annual growth rate g represents the essential boundary between investment and speculation (which, if it has a positive expected value and repeatability, is not equivalent to gambling), though in fact, this involves two valuation methods. Let me elaborate.
1. Finite-term valuation (calculating the sum of discounted cash flows over a certain period, excluding terminal value)
Mathematical formula for discounted cash flow (a more readable version of the formula can be found online):
Let the base period cash flow be C0 (t = 0)
Cash flow in year t ≈ C0 × (1 + g)^t
Total cash flow over n years = Σ_{t=1}^{n} C0 × (1 + g)^t
Total discounted cash flow over n years = Σ_{t=1}^{n} C0 × (1 + g)^t / (1 + r)^t
Cash flow in year t ≈ C0 × (1 + g)^t
Total cash flow over n years = Σ_{t=1}^{n} C0 × (1 + g)^t
Total discounted cash flow over n years = Σ_{t=1}^{n} C0 × (1 + g)^t / (1 + r)^t
To make it more intuitive, we plug in specific numbers:
Assume a company's current free cash flow C0 = 10 billion yuan. If you determine that this company has a moat, allowing its cash flow to grow steadily at g = 10% for the next 10, 20, and 30 years, with a discount rate of r = 8% for testing purposes.
Then:
Cash flow for Year 1 ≈ 10 × (1 + 10%)¹ = 1.1 billion
Year 5 cash flow ≈ 10 × (1 + 10%)⁵ ≈ 1.61 billion
Year 10 cash flow ≈ 10 × (1 + 10%)¹⁰ ≈ 2.59 billion
Year 20 cash flow ≈ 10 × (1.1)²⁰ ≈ 6.73 billion
Year 30 cash flow ≈ 10 × (1.1)³⁰ ≈ 17.45 billion
Year 5 cash flow ≈ 10 × (1 + 10%)⁵ ≈ 1.61 billion
Year 10 cash flow ≈ 10 × (1 + 10%)¹⁰ ≈ 2.59 billion
Year 20 cash flow ≈ 10 × (1.1)²⁰ ≈ 6.73 billion
Year 30 cash flow ≈ 10 × (1.1)³⁰ ≈ 17.45 billion
Discount the cash flow of the next 10 years back to today at 8%:
Sum of discounted cash flows after 10 years ≈ approximately 11.08 billion yuan
Sum of discounted cash flows after 20 years ≈ approximately 24.39 billion yuan
Sum of discounted cash flows after 30 years ≈ approximately 40.37 billion yuan
Sum of discounted cash flows after 20 years ≈ approximately 24.39 billion yuan
Sum of discounted cash flows after 30 years ≈ approximately 40.37 billion yuan
The sum of these FCFs represents your judgment of the company's intrinsic value today over a 10, 20, or 30-year period, assuming the moat holds and growth is replicable (excluding terminal value). This can be used alongside the current market cap to determine whether the stock is currently overvalued or undervalued.
2. Infinite-term valuation (calculating the intrinsic value of a company over its entire lifecycle, which is inherently the terminal value)
Using a simplified variation of the Gordon Growth Model (GGM), it's actually possible to back-calculate 'g' (the implied long-term growth rate expectation based on the current stock price).
Value (Market Cap) ≈ FCF / (r - g)
Implicit assumption: It assumes that the company will grow perpetually (i.e., n = ∞) and that the growth rate g will remain constant forever. The discount rate r must be greater than the growth rate g. In other words, only when g falls to a level similar to inflation or GDP does it meet the Gordon Model's requirement of being 'much smaller than r'.
For instance, using the current $Apple (AAPL.US)$ market cap and stock price to calculate:
Market Cap ≈ 3.7 trillion
FCF ≈ 100 billion
r = 8%
That is to say:
r - g ≈ 1000 / 37000 ≈ 2.7%
FCF ≈ 100 billion
r = 8%
That is to say:
r - g ≈ 1000 / 37000 ≈ 2.7%
g ≈ 8% - 2.7% ≈ 5.3%
If your judgment is that $Apple (AAPL.US)$ the future return will outperform a perpetual growth rate of 5.3%, then the current price is a bargain.
However, one thing to note here is that while the mathematical logic makes sense, there are a few pitfalls in practical application:
🔴Extremely sensitive to the definition of r: The calculation above assumes a discount rate r = 8%. If r were to increase to 10%, the calculated implied growth rate g would rise significantly. If the denominator (r - g) changes by just 1%, the final valuation could double or be cut in half.The value chosen for r is often subjective。
🔴Volatility of FCF: The current free cash flow used is 1 trillion. If this year is a peak performance year for Apple, using this base to extrapolate would be overly optimistic; if it's an off year, it would be overly pessimistic. It’s usually recommended to use 'normalized cash flow'.
🔴Ignores cash and debtStrictly speaking, market capitalization (Market Cap) is not equal to enterprise value (V). If a company carries heavy debt or holds a large amount of cash, directly comparing market cap with FCF will lead to deviations.
🔴Extremely sensitive to the definition of r: The calculation above assumes a discount rate r = 8%. If r were to increase to 10%, the calculated implied growth rate g would rise significantly. If the denominator (r - g) changes by just 1%, the final valuation could double or be cut in half.The value chosen for r is often subjective。
🔴Volatility of FCF: The current free cash flow used is 1 trillion. If this year is a peak performance year for Apple, using this base to extrapolate would be overly optimistic; if it's an off year, it would be overly pessimistic. It’s usually recommended to use 'normalized cash flow'.
🔴Ignores cash and debtStrictly speaking, market capitalization (Market Cap) is not equal to enterprise value (V). If a company carries heavy debt or holds a large amount of cash, directly comparing market cap with FCF will lead to deviations.
In addition, when calculating perpetual growth (i.e., the value of a company over its entire life), g usually must:
🔴Be less than or equal to the long-term GDP growth rate of the country it is in: typically between 2% - 4%.
🔴Reason: If a company’s perpetual growth rate g consistently exceeds the GDP growth rate (e.g., 6%), then mathematically, this company would eventually buy up the entire planet, which is obviously unrealistic.
🔴Be less than or equal to the long-term GDP growth rate of the country it is in: typically between 2% - 4%.
🔴Reason: If a company’s perpetual growth rate g consistently exceeds the GDP growth rate (e.g., 6%), then mathematically, this company would eventually buy up the entire planet, which is obviously unrealistic.
Because of these drawbacks, valuation isn't straightforward, which is why the masters say that when it comes to valuation, 'an approximate precise is more meaningful than a precisely vague' figure. My understanding is that for a 1. finite-period valuation, the more complex the calculations, the easier it is to lose accuracy.
For retail investors, this is essentially the most complex math required for rational investment.Lately, people often ask questions like 'Can I buy at this price?' or 'Is this company a good buy?' The above is the ultimate answer to such questions. According to Duan Yongping,If you're still asking "whether it can be bought," chances are you haven't figured out the company's moat, and naturally, you won't be able to determine the long-term replicable growth rate g. Under these circumstances, discussing price is meaningless.
Peter Lynch has always emphasized 'buying companies you understand', especially products you are currently using. Essentially, this is also a way of understanding the moat and future cash flow from a user's perspective.
When you are a real user, it’s easier to judge: whether the product is irreplaceable, whether user stickiness truly exists, and whether such usage behavior can be converted into stable cash flow over the long term, which allows for estimating the replicable growth rate g.
Many investment masters have different methodologies on the surface—some talk about valuation, others discuss cycles or management—but when viewed from a higher dimension, they essentially resonate: truly valuable judgments come from a deep understanding of how businesses operate, not from price alone.
Take a simple example: Uber in Australia, at least from the user experience perspective, is a very mature and frequently used product. But if you only focus on stock price movements, it’s easy to arrive at completely opposite emotional judgments.This precisely illustrates that if you start only from price, it’s hard to truly understand a company; instead, starting from the product, users, and usage behavior makes it easier to assess whether its long-term business value stands.Once you understand this, you'll see why Duan Yongping didn't sell his Moutai shares first. $Kweichow Moutai (600519.SH)$ (One of the reasons), the stock price has been falling for the past four years.
The share prices of many companies fall often because institutions predict intensified competition and a potential reduction in market share, thus giving a negative valuation first. The stock price begins to drop as the valuation is adjusted downward. For example: $Adobe (ADBE.US)$ Recent stock prices, but one point is often overlooked here (Duan Yongping's explanation of market share in his book is very insightful):Market share has always been an outcome, not a cause. Over a longer timeline, only if a product truly works well will users continue to choose it over the long term, allowing market share to accumulate naturally—just look at Apple for clarification.
So, everyone can focus more on companies with good products and services (this does not mean they are necessarily investment opportunities) rather than the stock price itself. Moo friends are also welcome to leave comments listing more good companies.
Lastly, I’d like to share my personal opinion on short-term P/L (profit/loss) in the stock market:
Short-term gains in the stock market mostly reflect timing and luck, while long-term gains show whether there is a stable and repeatable money-making structure. If a method proves valid across different environments over 10 or 20 years, that itself speaks volumes, which is where the true mastery of investing lies.So, thinking you’re great just because you outperformed the S&P 500 during a short-term bull market is actually dangerous. Most likely, you'll end up losing money, starting from a lack of respect for the market (a common weakness among retail investors).One of the hidden benefits of reading masterful books is to constantly remind oneself to 'respect the market'; those who read will naturally understand.
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0xdylan
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“In the short run, the market is a voting machine but in the long run, it is a weighing machine.” - Benjamin Graham
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Random Walk : I was a sell-side analyst for decades churning out investment analysis / reports for bulge brackets clients. The "reports" circulating in trading chat rooms often are merely summary of market news or traders' personal objective / subjective comments without any financial modelings backing the assumptions. It's truly refreshing to see people remember the DDM, DCF and Gordon Growth Model. Thank you very much for sharing indeed.
0xdylan OP Random Walk : Thank you for the recognition. The original intention of writing this piece was actually to bring investment judgment back to first principles—the most basic cash flow and assumptions. I'm not formally trained in finance; I've mostly learned through self-study and exploration. To receive resonance from senior professionals in the field is incredibly encouraging.![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")
DashXZ : good article. like a small part of basic 101.
from a retired analysis, I'll like to add, at least know some basic technical chart reading, company valuation method, understanding basic financial jargon. it will help with investing. also read news always (especially after investing).
markets are very unpredictable and often the hype is very out of control. another note to add, watchout of scam tips online from so call gurus.
thanks for your effort in writing a long one.
韭病成醫 : I've bought two books about Duan Yongping: 1. The Essence of Investment, 2. The Biography of Duan Yongping. I really agree with his business management philosophy, and the investment concepts are very close to Buffett's.
However, after reading the above two books, I feel that the content is too repetitive? Moreover, neither book was written by Duan Yongping himself.
The book 'Investment Q&A' by Dayao probably contains content similar to an interview between the CEO of Xueqiu and Duan Yongping?
So, is this book by Dayao worth buying?
0xdylan OP 韭病成醫 : I'm reading "The Great Dao", and I've always believed that only by listening to the author's own words can you better understand his true thoughts. When others interpret writings, they tend to add their own understanding and perceptions, which may lead to distortion. I highly recommend this book, "The Great Dao". It’s not just about investment; it also offers deep insights into business management and life in general.
0xdylan OP DashXZ : Agree, thank you for your support![[undefined]](https://static.moomoo.com/nnq/emoji/static/image/default/default-black.png?imageMogr2/thumbnail/36x36 "undefined")