One of my favorite investors to follow and study is François Rochon, the founder and president of Giverny Capital, a wealth-management firm he established in 1998. He is a renowned value investor who follows the principles of Warren Buffett, focusing on long-term investing and intrinsic value. Rochon is known for his disciplined approach, emphasizing "owner's earnings" and the importance of understanding a company’s real economic performance rather than relying solely on market prices. His investment philosophy prioritizes buying quality companies with strong growth prospects and holding them for the long term.
I have tried to distill Rochon's theory of intrinsic value in this post. When it comes to evaluating stock portfolios, it’s easy to get caught up in the daily market fluctuations. Most investors, especially those new to the game, focus on price movements and make decisions based on how much their portfolio has gained or lost in value. But is this really the best way to measure your investments? According to value-investing principles championed by legends like Warren Buffett and Rochon, the answer is no. The true worth of a portfolio lies not in its market value, but in its intrinsic value—more specifically, in what’s known as “owner’s earnings.”
What Are Owner’s Earnings?
The idea of owner’s earnings was popularized by Buffett in the late 1980s. Unlike market prices, which can be driven by temporary sentiment, owner’s earnings offer a clear picture of the actual value being created by the companies you invest in. Instead of focusing on how the market is valuing a company at any given moment, owner’s earnings look at the company’s real economic performance.
Here’s how it works: Imagine you hold a portfolio of stocks, and you want to understand how much value they’re generating for you. One way to do that is by adding up the pro-rata earnings per share from each company in your portfolio. For example, if your portfolio holds $100,000 worth of shares in companies ABC and XYZ, you’d look at the earnings per share of those companies and multiply them by the number of shares you own. The result is your “owner’s earnings” for the year.
Why This Matters for Long-Term Investing
Market prices can be misleading. Just because a stock’s price is going up doesn’t mean the business is actually growing in a meaningful way. By focusing on intrinsic value, you can filter out the noise and get a better sense of whether your investments are truly on the right track. Over time, the intrinsic value—reflected in consistent growth in earnings—should drive the market price higher.
But there’s a key insight here: it’s possible to pay too much for a stock, even if its intrinsic value is increasing. If you buy at a price well above a company’s intrinsic value, it could take years to see meaningful returns, as the market eventually adjusts.
How to Calculate Intrinsic Value for Your Portfolio
Let’s break it down with an example. Say you have $100,000 invested across two companies, ABC and XYZ. If ABC earns $2 per share and XYZ earns $8 per share, you would calculate your total owner’s earnings based on how many shares you own of each. If your total owner’s earnings for the year are $8,000 and that number grows to $9,300 the next year, you’re seeing an increase in intrinsic value. By consistently tracking these earnings over time, you can better gauge your portfolio’s real worth, without being swayed by temporary market movements.
The Power of Looking Through Earnings
For seasoned investors, focusing on intrinsic value is nothing new. Buffett has done it for decades, using owner’s earnings as a key metric to determine whether a company is a good long-term investment. Rochon adopts a similar approach by calculating the annual earnings growth of his portfolio companies and comparing that to their market price growth. His conclusion? Over the long run, companies that consistently increase their earnings will outperform the market, even if their share price doesn’t reflect it right away.
Why This Approach Works
This method works because it aligns your investment strategy with long-term goals, rather than short-term price movements. It also keeps you focused on the actual business performance of the companies you invest in, rather than getting distracted by the daily noise of the market.
In a world where speculation often overshadows value, focusing on intrinsic value and owner’s earnings can provide a much-needed anchor. Instead of reacting to market highs and lows, you’re assessing the real engine behind your portfolio’s growth—the businesses themselves.
Conclusion: Invest Like a Business Owner
If you want to invest with the confidence that comes from understanding your portfolio’s true worth, start focusing on intrinsic value. Treat your investments as if you own the entire business, and evaluate them based on the earnings they’re generating. In the end, this approach is more rational, more stable, and more likely to deliver long-term success.
