Value Investing Some ideas on valuation and the flaws of relying on it |
- Some ideas on valuation and the flaws of relying on it
- Canada Goose: Do not Kill the Goose that Laid the Golden Egg
- Cash-cow Chinese Aquarium Operator
| Some ideas on valuation and the flaws of relying on it Posted: 29 May 2019 01:39 PM PDT Hey everyone, I just joined this sub after I was looking for a place I could get some feedback on some thoughts I've been developing about equity valuation. This likely is all a bit jumbled, so I apologize in advance. As a disclaimer, I'm likely wrong about some (if not all) of this, but I've been thinking about it for some time and can't find where I might be wrong. Basically, I've been thinking lately about how analysts spend so much time building hyper-complex three-statement models, complete with revenue builds and an absurd number of line-items. Now, these are absolutely useful in understanding a company's financial condition, margins, growth, etc, but are extremely unreliable when trying to determine what price to purchase a stock at. There is far too much ambiguity. If you, me, and ten others all built a model and DCF valuation for P&G, we would likely all come up with a different price target. Plus, even if an analyst can perfectly project a company's financials and link it all into a FCF DCF, there is no guarantee the company's stock price will align with its calculated intrinsic value. A stock price represents the consensus view of millions of individuals at a given point in time, and if they are all determining their opinion using different models and valuation methods, the stock's price won't line up precisely with the target of the one analyst who did it correctly. So, since projecting a precise target is not an effective way to generate alpha, what is? Well, many analysts rely on sell-side price targets for the trajectory of a stock, believing that, over time, a stock's price will roughly follow the trajectory of its earnings. They think if a stock is trading at $50 and the Wall Street consensus target is $60, the stock will trend upwards. In some sense this may be true if enough investors take action on the Wall Street recommendation. I could go on longer in another post about why I think Wall Street recommendations should be taken with a New York-sized grain of salt, but I'll just give the executive summary of my current opinion: analysts have rarely been accurate with their price targets in the past. Most use comp multiples in their valuations, which are a) extremely subjective to manipulation, which is problematic since analysts are incentivized to put out "buy" recommendations, and b) inherently ignore the state of the broader market (if the entire market or sector is overvalued, the comp multiple will be unjustifiably higher). Plus, sell-side analysts do not have (to use Nassim Taleb's phrase) skin in the game with their recommendations - aka they do not have to put their money where their mouth is. Many investors end up going deep into the weeds in building monster financial models for their valuations. I'll admit it can be fun doing this as a sort of puzzle. But, I believe that after a certain point the more complex the model, the less accurate. There's a fascinating study about professional odds-makers for horse racing. A group of them were asked to place odds on a race between 10 horses, and were told they could have any 4 pieces of data for comparing them (i.e. jockey weight, age, breed, etc). They forecasted with 19% accuracy, which is not half bad. They reported they felt about 10% confident (I may have the numbers slightly off) in their conclusions. Then, they were asked to project another race, and this time were given more pieces of information. After several iterations of this (up to something like 30 pieces of data), their accuracy had remained about constant, but their confidence had risen significantly despite the stagnation in accuracy. So, complexity and extra information is not always as beneficial as one may intuitively think. The main conclusion I've come to is that there must be a more simple way to value a stock that accounts for reality - meaning the actual behavior of the market - along with some degree of fundamentals instead of all one or the other. For example, I've been considering this valuation technique:
This method would only require calculating a growth rate. This could be done with a simplified income P&L forecast sheet, and would be easy to run a sensitivity analysis on. The qualitative factors are, therefore, the most important piece of your analysis. There have also been studies showing that people making decisions who have lots of quantitative data will overweight their decisions towards quantifiable indications while missing qualitative ones. Buffet and Munger do not spend their time modeling out depreciation and CAPEX or equity issuances. This is not to say these factors should be ignored, but there is an opportunity cost in spending too much time on them, and, according to what I've seen, decreasing marginal returns the deeper into the weeds you get. I remember a speech where Munger was asked, "What is the best investment advice you could give someone starting in the industry?" He responded, "Most people seem to think we use some magic formulas and complicated ideas to make decisions. Back a few decades we just saw most cities had only one major newspaper, and some had two with one slowly dying. So we bought all the good ones. Does that seem like a complicated idea?" Anyways, looking forward to hearing any thoughts on this. [link] [comments]  |
| Canada Goose: Do not Kill the Goose that Laid the Golden Egg Posted: 29 May 2019 07:14 AM PDT The 22% decline in the stock price for Canada Goose (GOOS) today, really goes back to what was said in this article: https://kpbco.org/onepir/do-not-kill-the-goose-that-laid-the-golden-egg . As value investors you should not pay a high price for growth. Management tends to make mistakes, and mis-earnings and revenue estimates, when that happens you will get caught off guard. Doesn't mean the company is a bad company tho. [link] [comments]  |
| Cash-cow Chinese Aquarium Operator Posted: 29 May 2019 05:24 PM PDT Founder led company that earned S$44mn last year on revenue of S$124mn. Most of the earnings came from 2 aquariums that made S$40mn. The company has S$165mn in net cash, and is currently valued at S$661mn. Adjusted for cash the market is valuing this business at 11x earnings. And last year one of their assets was closed for 2 months, which is unlikely to be repeated. Earnings are probably going to be more like S$49mn. They were S$50mn in 2017. So based on that, the market values the business at 10x earnings. You can read the rest at https://netosnotes.files.wordpress.com/2019/05/conclusion-1.pdf [link] [comments]  |
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