May 2024

Investing is about giving up a dollar today to expect more than a dollar back tomorrow. We can put it into an equation:

<aside> 🧮 give up $X to buy an asset Z with its intrinsic value greater than $X.

</aside>

Intrinsic value is the sum of all future earnings.

There are 2 young adults. One is currently in medical school. The other is flipping burgers at McDonald’s full-time. The medical student is $200k in debt and earns no income. The McDonald’s worker earns $15 an hour and has $10k in savings.

On paper, the McDonald’s worker is financially better than the medical student.

Let’s look at each of their current annual earning power:

• Medical student: $0
• McDonald’s burger flipper: $28,800 ($15/hr * 8 hours/day * 20 days/month * 12 months)

Now, let’s ask a simple question. Say, you get to receive 1% of the annual earnings from either one person, for the rest of your life, who would you pick?

Your intuition will point you to choose the medical student despite the current $0 annual income and much debt. That’s because you would intuitively consider their future earnings power.

Statistically, once the medical student becomes a full-time doctor, that person will make over $200k to $500k per year with a bright prospect of making more. On the other hand, the wages of a burger flipper can barely catch up to inflation.

The numbers on paper can be referred to as book value, drastically different from the intrinsic value, or the “reality of the situation”.

A simple calculation with the given numbers will guide us to pick the burger flipper. But, to understand the “reality of the situation”, we have to add other right variables to the equation using our intelligence, such as:

• How likely is a medical student going to become a licensed doctor?
• What will be the future earnings power of a doctor?
• What are the prospects of medical professionals? Is technology going to replace them?
• How fierce is the competition among doctors? Are doctors easily replaceable? Will the market be flooded with lots of doctors? Are doctors going to be commoditized?

Now, we can also ask similar questions on the burger flipper. It’s easy to conclude that the intrinsic value of a medical student after paying off the student debt will likely far exceed that of the burger flipper even though the book value says otherwise. We care about how much earning power is in the long run. The intrinsic value is the sum of all future earnings$^1$.