The Art and Science of Stock Valuation, by Chris Morrissey
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 unique alpha- generating market strats. There are Fantasy League winners using every and all technique, but today, we’re focusing exclusively on the most arcane!
Superinvesting legends have built great fortunes on 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 if you can pin it down. The likes of Warren Buffett have made billions by hoovering up stocks that trade at apparent discounts to their intrinsic 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, however, simply the back of a napkin and some common sense is all you need!
It’s no exact science. Due to differences of opinion and risk tolerance, there’s rarely such a 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 psyche, or how Microsoft, Apple, Disney, and Nike et al have somehow made one plus one equal three!
So, how does it work? Companies headed for bankruptcy usually have debts and losses threatening to burn away value until their final day, like melting ice cubes. In such scenarios, the most an investor should pay is the value physical assets, like machinery, would carry in a flash sale. But in all the more positive scenarios, a business is worth – to the final penny – the money it will put in investors’ pockets.
Thanks to the ‘time value of money’, we can predict how the profit of a company might grow into perpetuity 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 theoretical long-term annual return from the stock. The last step is to apply a wide margin of safety to the final figure, and then wallah; you’ve hand-cranked what your favourite brand is worth!
Check out our step-by-step tutorial in stock valuation here [link]!
