78  •   The Intelligent Option Investor
money and discount rates, but even being unacquainted with these terms 
right now will not be a handicap. 
Business is essentially a collection of very simple transactions—pro-
ducing, selling, and investing excess profits. In my experience, one of the 
biggest investing mistakes occurs when people forget to think about busi-
ness in terms of these simple transactions. 
Having a firm grasp of valuation is an essential part of being an in-
telligent option investor. The biggest drawback of the BSM is its initial as-
sumption that all stock prices represent the true values of the stocks in 
question. It follows that the best opportunity for investors comes when a 
stock’s present price is far from its true intrinsic value. In order to assess 
how attractive an investment opportunity is, we must have a good under-
standing of the source of value for a firm and the factors that contribute to 
it. These are the topics of this chapter and the next. 
In terms of our intelligent option investing process, we need two 
pieces of information:
1. A range of future prices determined mechanically by the option 
market according to the BSM
2. A rationally determined valuation range generated through an in-
sightful valuation analysis
This chapter and the next give the theoretical background necessary to de-
rive the latter. 
Jargon to be introduced in this chapter is as follows:
Asset Structural constraints
Demand-side constraints Supply-side constraints
Owners’ cash profit (OCP) Expansionary cash flow
Free cash flow to owner(s) (FCFO) Working capital
The Value of an Asset 
The meaning of asset , in financial terms, is different from the vernacular 
meaning of “something I’ d be upset about if it broke or was stolen. ” In 
financial terms, an asset is anything that can be owned that (1) was created