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I know many value investors emphasized that we need to buy a stock with margin of safety since our estimation for intrinsic value is not precise. By this way, we can lose less when our estimation is wrong and we can earn a lot if our prediction is correct.

My question is that if the intrinsic value we calculated is correct and we buy the stock at its intrinsic value and sell it at its intrinsic value several years later, is the annual return rate for holding this stock equal to discount rate?

(Assumptions: 1.We use DCF model to calculate intrinsic value. 2.We assume our estimation for intrinsic value is correct. 3.We assume the discount rate and the company's grow rate does not change during these years. )

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Yes, given your assumptions, your nominal rate of return will equal the discount rate. Nominal, because nothing in the formula adjusts for inflation.

For business valuation purposes, the discount rate is typically a firm’s Weighted Average Cost of Capital (WACC). Investors use WACC because it represents the required rate of return that investors expect from investing in the company.

https://corporatefinanceinstitute.com/resources/knowledge/finance/what-is-wacc-formula/

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  • Thanks for your clear answer. Commented Mar 13, 2022 at 15:35
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Just to nitpick a bit - there is no 'correct" intrinsic value. You can calculate an "intrinsic value" based on different methods (DCF, fundamentals, etc.) that uses some rate (or rates) to discount future cash flows. If you buy the stock at one price and sell it for another, the return on that investment is not necessarily the same as the discount factor used to calculate either price. The value now could be based on a different discount rate, or the cash flows could be different that predicted.

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  • Thanks for your reply. I just edit my question to make it clear. Based on my calculation, I think they are equal under my assumptions. Just want to make sure my calculation is correct. Commented Mar 9, 2022 at 16:54
  • If you use the same discount rate for the beginning and ending price, and do not change any cash flow assumptions, then yes, the CAGR (annual rate of return) will equal the discount rate. I'm just struggling to see the point of the seemingly academic exercise.
    – D Stanley
    Commented Mar 9, 2022 at 19:27
  • Thanks. The reason is that every famous value investor emphasized that we need to buy stocks with margin of safety and we need to know it very well. However, in real world, it is pretty difficult for people to find stocks which they know very well and are also very cheap (40% or 30% less than intrinsic value). Therefore, I made several assumptions and try to figure out what return rate investors will get if they are buying stocks at their intrinsic value. Commented Mar 11, 2022 at 9:14
  • I understand that there are many factors in the world which would finally influence investors' performance. My question may not be that useful and practical for many people. But it is pretty meaningful to me. Commented Mar 11, 2022 at 9:16

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