Valuing Assets: Warren Buffett Style

Warren Buffett revealed his secret to valuing all assets in the Berkshire Hathaway Annual Report from 2000 when he said "a bird in the hand is worth two in the bush.” But in order to fully complete the formula, Buffett said that we must answer the following three questions:

  1. How certain are you that there are indeed birds in the bush?
  2. When will they emerge and how many will there be?
  3. What is the risk-free interest rate?

Once these questions are answered, you can figure out the maximum value of the bush and the number of birds in the hand. Of course, don't be so literal in your application of Buffett's advice. "Think dollars,” he said.

According to Buffett, this law is immutable and applies to anything, including the purchase of farms, bonds, stocks, and lottery tickets. Buffett says to make sure to use the correct numbers when you use this formula. In this article, we use Buffett's advice to compare attending an Ivy League university to its public and private contemporaries. By doing so, we can answer the question, is an Ivy League degree worth it?

Key Takeaways

  • Crunch the numbers before you choose a public, private, or Ivy League university.
  • Consider how much you'll have to spend on tuition and fees, along with the potential for earnings in the future.
  • Use the average annual wage growth to determine future salaries based on the current estimate.
  • You can use the 30-year T-Bill to determine the equity risk premium or discount rate for your educational investment.
  • Using 2020-2021 figures, the public school option is the best route to take, as it has the lowest cost and the highest rate of return.

What to Consider Before You Apply

Going to college or university is just like any other type of investment. There are a number of different factors you need to consider. And you need to weigh out the pros and the cons. This leads us to a discounted cash flow model that requires four key inputs:

  1. The price tag or the cost of the investment, which in this case is the cost of a four-year degree.
  2. Current earnings, or the starting salary after receiving a four-year degree.
  3. A discount rate.
  4. Growth rates.

Now let's crunch the numbers and see how they fit into Buffett's advice.

Work Out Your Tuition and Fees

Let’s first determine the total cost for a four-year education at public, private, and Ivy League institutions. It is necessary to use a starting point of 2020-2021 tuition and fees and inflate them each year for four years by an average tuition inflation rate to reach a total four-year cost.

Collegedata.com reported that tuition and fees for public and private universities in the 2020-2021 academic year were $26,820 and $54,880 respectively. According to College Tuition Compare, the average Ivy League education cost students $56,425 for the 2020-2021 school year. The average annual tuition rate increase from 1958 to 2001 was 8%, according to FinAid.org.

We can use this information to inflate tuition and fees for four years to arrive at a total cost for each of our collegiate buckets:

2020-2021 to 2023-2024 Tuition and Fees Based on an 8% Tuition Inflation Rate

 

Public

Private

Ivy League

2020-2021

$26,820

$54,880

$56,425

2021-2022 (est.)

$28,966

$59,270

$60,939

2022-2023 (est.)

$31,283

$64,012

$65,814

2023-2024 (est.)

$33,786

$69,133

$71,079

Four-Year Total Cost

$120,855

$247,295

$254,257

How Much Can You Make?

Our cash flow model depends on an earnings stream that can grow over time at a realistic rate, so you should determine how much you can expect to earn after graduation. Keep in mind, our hypothetical scholar won't graduate until 2024, so it is necessary to inflate the starting salary to 2024 expectations.

Using data mining and statistical modeling, Payscale.com provides starting salaries for each of our collegiate buckets. The top eight reported school salaries for each college category were averaged together to find the 2020 starting salaries. The results are as follows:

  • Public: $77,500
  • Private: $80,862
  • Ivy League: $73,575

Now let's inflate these salaries to a 2024 figure. The average annual wage growth rate from 1960 to 2021 was 6.08%. Since we are equating our college returns to long-term investment, this is an ideal growth rate. In the following table, the 20 starting salaries were increased by 6.08% a year for four years to arrive at a 2024 hypothetical starting salary.

Starting Salaries Increased at 6.08% a Year 2021 to 2024
  Public Private Ivy League
2021 $77,500 $80,862 $73,575
2022 $82,212 $85,778 $78,048
2023 $87,210 $90,993 $82,794
2024 $92,512 $96,526 $87,828

The scholar graduating who graduates in 2024 can expect to earn an average starting salary of $95,512, $96,526, or $87,828 for a public, private, or Ivy League education respectively.


Use earnings in place of starting salaries in the cash flow model when you want to determine the viability of purchasing specific stocks.

Quick Valuation Ratios

The information gathered so far can be used to determine the future value of the starting salaries and to calculate quick valuation ratios to calculate initial value indicators. These ratios are not necessary for our discounted cash flow (DCF) model, but they do provide corroborating evidence to our eventual cash flow model.

First, let’s estimate what each tier resulting salaries will be paid in 10 years. The following table shows the starting salaries for each tier projected forward ten years, using the time value of money (TVM) calculation for future value and the 6.08% annual growth rate.

Expected 2031 Salary Based on 2021 Starting Salary and 6.08% Annual Wage Growth

 

Public

Private

Ivy League

2021 Starting Salary

$77,500

$80,862

$73,575

2031 Projected Salary

$139,842

$145,908

$132,759

P/Y

1

1

1

PV

$(77,500)

$(80,862)

$(73,575)

N

10

10

10

I/Y

6.08%

6.08%

6.08%

CPT FV (2031 Projected Salary)

$139,842

$145,908

$132,759

According to these projections, a college grad from a public university can expect to make $139,842 by 2031, while a private and Ivy League grad can expect to make $145,908 and $132,759 respectively.

These salary calculations put into place some quick valuation ratios:

Starting Salary to Cost Ratios

 

Public

Private

Ivy League

Four-year Cost

$120,855

$247,295

$254,257

2021 Starting Salary

$77,500

$80,862

$73,575

2031 Projected Salary

$139,842

$145,908

$132,759

Cost to 2021 Starting Salary

1.56

3.06

3.46

Cost to 2029 Projected Salary

0.86

1.69

1.91

Think of these ratios as the equivalent to price-to-earnings (P/E) ratios used for stocks that provide quick, value-at-a-glance insight. And remember, the lower, the better.

You can see that going to a public university comes out as a clear winner if we consider the ratio of cost to 2021 starting salary compared to the other two options. The public tier drops even further to a mere 0.86 for the cost-to-2029-projected-salary ratio compared to 1.69 and 1.91 for private and Ivy League institutions. Remember, the lower, the better. So, a public school education clearly offers greater value than its rivals.

The Discounted Cash Flow Model

Now let’s move on to our DCF model, which is truly the point of this exercise. Remember, the following inputs are necessary to build the model:

  1. The cost of a four-year degree.
  2. The starting salary after receiving a four-year degree.
  3. A discount rate.
  4. Growth rates.

We have already determined the total 2020-2021 to 2023-2024 tuition and fees (cost) for attending each tier, and we determined the 2021 starting salaries for each. Now, let’s decide on a discount rate and growth rates.

The Discount Rate

The discount rate is the rate used to discount future earnings back to a present-day dollar figure and will be a combination of the risk-free rate that is the 30-year Treasury Bill (T-Bill) rate and an equity risk premium (EPR). The reasoning behind this is that the 30-year T-Bill rate is what an individual investor can expect to gain in return (risk-free) if the money to attend college was invested instead.

The equity risk premium reflects the uncertainty over what the future salary will be. The 30-year T-Bill is 2.15% as of June 11, 2021, while the equity risk premium is 4.20% as of June 2021. The total discount rate will, therefore, be 4.20%.

First and Second Stage Growth Rates

The growth rates will be the rates used to grow the starting salaries to a future value. As noted above, the average annual wage growth rate between 1960 to 2021 was 6.08%. This figure will be used for both the first- and second-stage growth rates.

A more short-term scientific analysis could be used to determine what the growth rate will be in the near term, but when it comes to forecasting, take the weight of a 55-year average over a short-term guess.

Summary of Inputs

The inputs for our discounted cash flow model are as follows:

Summary of Discounted Cash Flow Model Inputs

 

Public

Private

Ivy League

Four-Year Cost (Tuition and Fees)

$120,855 

$247,295

$254,257

Discount Rate

4.20%

4.20%

4.20%

2021 Starting Salaries

$77,500 

$80,862

$73,575

First and Second Stage Growth Rates

6.08%

6.08%

6.08%

The Results

We arrive at the following results using the inputs listed above, including the discount rate, time value of money:

Net Present Value and Rate of Return Based on Four-Year Cost
  Public Private Ivy League
NPV $777,773 $687,664 $596,444
Four-Year Cost $120,855 $247,295 $254,257
Rate of Return 51.6% 44.6% 44.6%

The ultimate goal is to arrive at a singular present value dollar figure (the figurative bird in the bush) that can be compared to other present value figures for other collegiate tiers and used to determine a rate of return (RoR) based on the initial investment or, in our case, the four-year tuition and fees for a degree. The model takes the starting salaries, projects them forward to a future value based on the growth rate, then discounts these future earnings back to a present-day dollar value using the discount rate.

From the results, a clear winner emerges—public schools have a net present value (NPV) of approximately $777,773 compared to $687,664 and $596,444 for private and Ivy League schools respectively. In relation to costs, public schools deliver a 51.6% return compared to 44.6% for private and Ivy League schools.

Corroborating value evidence was also previously supported by our cost-to-salary ratio analysis, which showed that public schools delivered a 1.56 cost to 2021 starting salary as opposed to 3.06 and 3.46 for private and Ivy League universities respectively.

The Bottom Line

Is an Ivy League education worth it? Our discounted cash flow model delivers a resounding no. According to this model, an individual is much better off value-wise to attend a public school as they can expect to receive a much higher return based on their invested tuition and fees. Of course, this analysis is based on many assumptions—tuition rates, wage growth rates, and discount rates.

It can also vary dramatically with the slightest of variances. Think of it as the Hubble Space Telescope. That is, adjust a knob in the slightest and you are looking at a completely different universe. Still, the assumptions are grounded in rationality, and the evidence is fairly damning for the Ivy League. No, it is not worth it.

We now know how many birds are in the bush, when they will emerge, and the discount rate. Based on this, a soon-to-be-scholar will be much better served value-wise by picking the shrub labeled public. It may not appear as illustrious as other elite topiaries, but it certainly will be filled with many birds. And of course, don’t literally think birds. Think of dollars.