Opportunity Costs: Prices Exist; Interest Rates Don't - More on Columella

by Geoff Gannon


I have a confession to make. I don’t look at bond yields. I invert bond yields to look at bond prices. Always have.

(Price = 1/Yield)

In one article: I multiplied a stock’s free cash flow by the inverse of the 30-year AAA bond yield to get the stock’s intrinsic value. That confused a reader:

“I am still a little confused why the price-to-coupon ratio is used as a multiplier.”

Investors choose between assets like stocks, bonds, and land. If bonds and land are expensive, people buy stocks and vice versa.

Think about Columella and his vineyard. It will cost Columella 32,480 sesterces to plant the vineyard and wait for it to give grapes. In two years: the vineyard will start giving him grapes. Columella will then sell those grapes for at least 2,100 sesterces a year.

His other option is lending the 32,480 sesterces at 6% a year. That would give Columella 1,950 sesterces a year (actually 1,948.8 sesterces; Romans had trouble with fractions).

There are two ways of looking at this choice. You can compare the two options – making a loan and planting a vineyard - in terms of yield: 2,100 sesterces a year is more than 1,950 sesterces.

Or you can compare the two options in terms of value:

2,100 * (1/0.06) = 35,000 > 32,480

I like the value way of looking at things better. It makes more sense to value bonds than discount everything else.

Here is the best thing I’ve read on this topic.