The Arty Science of Stock Valuation
From reading charts for technical signals to riding up momentum and playing the contrarian, you, the community, have turned the Invstr feed into a live showreel of alpha-generating market strats. There are fantasy league winners using all and each, but today, we’re focusing exclusively on the most arcane!
Superinvesting legends have built great fortunes on top of genius-inspired predictions about the future. But not without help. You see, the complex inner labyrinth of a modern company can actually be condensed into a single value, which is pretty useful to know. The likes of Warren Buffett have made billions by hoovering up stocks that trade at “bargains” to their fair-ish values.
This market play is one of the oldest in the book. First pioneered by Ben Graham in the 1920s, endless academic models have sprouted up since his time claiming to put you in the ballpark of a magic buy price. In some cases, though, the back of a napkin and some common sense is all you need!
Companies heading for bankruptcy usually have debts and losses threatening to burn away value until day zero, like a melting ice cube. In such a dumpster fire scenario, the least an investor should pay for is what the physical assets, like the machines, are worth in a flash sale.
Otherwise, a business is worth – to the final penny – the profit it will put in investors’ pockets. Thanks to the ‘time value of money,’ we can predict how profit might grow into infinity without arriving at an infinite value per share. To reflect risk, everything is peeled back by a discount rate, and that rate also doubles up as our long-term annual return from the stock (hopefully compensating us for said risk!). Finally, a wide margin of safety is applied to the final valuation and wallah! You’ve hand-cranked what Tesla is worth.
It’s not an exact science. Due to differences of opinion and risk tolerance, there’s rarely such thing as an “undervalued” or “overvalued” stock on an absolute basis. The main reason investors include valuation in their arsenal is to help them figure out what an investment is worth to them. Formulas do very little to explain why stocks move, the human psychy, or how Microsoft, Apple, Disney, and Nike et al. made one plus one equal three!