This is Part 2 of a Series. Go to Part 1: On Price, Value, Value Investors, and Equity Perpetuity
The following are excerpts from a discourse I had with a fellow investor with regards to realizing gains, compounding value, and equity perpetuity. Let me stress that I don’t claim these constitute canon—these are just my own personal views.
On stocks being perpetuity annuities: I'm not saying stocks are exactly perpetuities. They are only similar to perpetuities with regards to the indefiniteness of their existence/expiration. Stocks with underlying excellent businesses can be likened to perpetuities in that they are indefinite and that they shall be producing earnings/cash profits year after year. Just think of businesses you know will not be closing anytime soon (or you know will be there even decades from now).
Again, from a value investor's point of view, earnings/cash profits need not be disbursed as cash dividends to consummate/experience or receive value—the owner mentality is always conscious on the level of the business and that's the sort of paradigm value investors try to psyche themselves into. If you start accepting that, you'll realize the relevance and applicability of the perpetuity formula in stock valuation even of businesses that don't pay out cash dividends.
But let me stress too: I am not saying that the fair value of a stock is exactly that of a perpetuity. What I am saying is: the value of a stock, if valuated using the perpetuity formula, is actually understated (because, as I've been saying this over and over again, stocks with excellent businesses actually grow their cash profits when perpetuities do not—they have flat payments forever). Thus, I only use and take advantage of the perpetuity formula to conservatively estimate a deep discount price to pay (or at least some safe baseline price figure) which would warrant capital preservation and some rational potency of earnings.
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