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A Bird in the Hand is Worth Two in the Bush - Understanding Time Value in Investing

Willem

Willem

A Bird in the Hand is Worth Two in the Bush - Understanding Time Value in Investing

A Bird in the Hand is Worth Two in the Bush

By Willem / Originally published: 22 March 2025 / Investment Philosophy

Table of Contents

The old proverb "a bird in the hand is worth two in the bush" contains profound investment wisdom that Warren Buffett has championed throughout his career. At its core, this concept is about understanding the true value of certainty versus potential. This timeless wisdom helps investors evaluate opportunities by considering the time value of money and opportunity costs. The word bird here means cash (so how much cash will a business earn in the future, or bush). Buffett mentions this in his letter to shareholders of 2000.

The Mathematics of Opportunity Cost

When we examine this through the lens of financial mathematics, the wisdom becomes even clearer:

- If you're offered 1 bird today versus 2 birds in 5 years, that represents a 15% compound annual growth rate (CAGR). - In an environment where interest rates are 5%, this is an excellent deal. - However, if interest rates are 20%, you'd be better off taking the bird now and investing elsewhere.

Time Value and Certainty Premium

As Buffett humorously puts it: "A girl in the convertible is worth 10 in the phone book." This colorful analogy highlights our natural preference for the certainty of what we have now versus promises of future returns.

The longer you must wait for your "birds in the bush," the more birds you should demand:

- If you pay $500 billion for a business with an expected 10% return ($50 billion), but receive nothing in the first year, you must earn $55 billion in the second year to maintain that rate of return. - By the third year, that grows to $60.5 billion (another 10% increase). - The question becomes: Can any business realistically deliver such increasing returns? Even Apple generates about $90 billion - how many companies can match or exceed that?

The Fundamentals of Value

Every business is ultimately worth the present value of its discounted cash flows until "judgment day." Buffett argues that all intelligent investing is value investing - you want to receive more than you pay for.

The calculation is straightforward:

1. How many birds are in the bush (potential earnings)?

2. When will you get them (timing)?

3. What are the current interest rates (opportunity cost)?

As Buffett stated in his letter to shareholders in 1992:

"The investment shown by the discounted-flows-of-cash calculation to be the cheapest is the one that the investor should purchase - irrespective of whether the business grows or doesn't, displays volatility or smoothness in its earnings, or carries a high price or low in relation to its current earnings and book value."

Growth Is Not Always More Birds

A critical insight: growth doesn't automatically translate to value. The fundamental question when considering a $100 billion investment in Berkshire Hathaway is: "What can we distribute in cash soon enough to make it sensible at present interest rates?"

Consider this comparison:

- Would you prefer 10% returns now or 2% returns with 10% growth? - It takes 50 years for the growing investment to outperform the immediate return!

The Two Kinds of Businesses

Charlie Munger provides clarity on this concept by distinguishing between two business types:

1. Businesses earning 12% where profits can be withdrawn annually

2. Businesses earning 12% where all excess cash must be continuously reinvested

As Munger colorfully explains:

"There are two kinds of businesses: The first earns twelve percent, and you can take the profits out at the end of the year. The second earns twelve percent, but all the excess cash must be reinvested-- there's never any cash. It reminds me of the guy who sells construction equipment-- he looks at his used machines, taken in as customers bought new ones, and says, 'There's all of my profit, rusting in my yard.' We hate that kind of business."

Pricing Power: The Ultimate Advantage

Companies with significant pricing power represent rare investment opportunities. Disney exemplifies this advantage:

"It's such a unique experience to take your grandchild to Disneyland. You're not doing it that often. And there are lots of people in the country. And Disney found that it could raise those prices a lot, and the attendance stayed right up...Once you figure that out, it's like finding money in the street-- if you have the courage of your convictions."

Conclusion

The wisdom of "a bird in the hand is worth two in the bush" reminds us to evaluate investments based on:

- The certainty of returns - The timing of cash flows - Current interest rates - The company's economic moat

By focusing on these fundamentals rather than speculative growth, investors can make decisions that truly account for the time value of money and opportunity costs. As Warren Buffett explains in his speeches and annual letters, this simple concept is at the heart of intelligent investing.

To reference Munger himself:

"All intelligent investing is value investing: want more than you pay for. Use filters for this, stick with great companies and sit on your ass because you correctly predicted the future."

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