One of the most important decisions you make with any investment is the price you pay. Your decision to invest in a company may also take into account your knowledge of the viability of its product and services. There are differing opinions as to the current market value of any company, but predicting a company’s future value is perhaps as uncertain as forecasting the weather: The further out the forecast, or the newer the business or product, the less predictable its future.
As a remedy to this uncertainty in the future, many advisors guide investors toward portfolio diversification, whose main tenet is eliminating the risk of investing in a company by spreading your money across a diverse set of investments. In essence, diversification in this fashion is designed to make up for a lack of valuation. Although this approach may indeed cushion your losses, it does so by spreading your money across multiple ventures. Effectively, you lose the gains you could have achieved with high conviction and more certainty. As the adage goes, “If you don’t care where you are going, any road will do.”
Valuation
Because we can’t predict the future, all methods of valuation involve comparable, historical performance and a whole lot of assumptions. You could very well invest in any company without worrying about its business valuation, just as you could live a happy, healthy life without ever knowing your health conditions. But as an investor, valuation is useful to know when you want to buy something.
Here are some basic valuation metrics that may be used to evaluate companies and their merits.
Valuation Warren Buffet Style
Warren Buffet has not hidden his loathing of the modern finance theory of portfolio diversification, comparing it to selecting a group of stocks by throwing darts. Instead, he emphasizes that investment should assess the fundamental characteristics of a company, its products, competitors, tax, debt levels and talent and the integrity of its management.
However, the business world is too complex for a single set of rules to effectively describe the economic reality of all enterprises. Hence, he reminds investors of Keynes, who believed that an investor should put fairly large sums into two or three businesses they know something about and whose management is trustworthy.
It is common practice to calculate cash flow as (a) operating earnings plus (b) depreciation and other non-cash charges. Buffet argues that it must also (c) subtract required reinvestment in the business, in order to calculate a true “owner earning.”
Another point he makes is that it is not the size of an equity investment that determines its value, but how the undistributed earnings are deployed. That is, how the retained earnings of a dollar are translated into two or more dollars of market value, instead of simply distributing it to shareholders. This approach forces investors to think about the long-term prospects of the company, rather than the short-term stock market price.
As Buffet said, “It’s true that in the long run, the scoreboard for the investment decision is the market price. But the prices will be determined by future earnings. In investing, just as in baseball, to put runs on the scoreboard one must watch the playing field, not the scoreboard.”
Limited Opportunities in Today’s Stock Market
Fewer and fewer high-confidence opportunities exist, given the rally in the stock market.
AI is undeniably a great opportunity, but how this technology turns into real value in a short period of time is the big question.
Lithium prices are cyclically at a low point, which has led to the cancelation of several production projects. However, as the total supply growth slows, the market will move into a supply deficit, leading prices to rise, probably in the second half of the year.
Bonds offer a great return now, and the price of long-duration bonds should increase as yields start to subside. The widely speculated rate cuts would only be a reaction to inflation moderation and/or economic weakness, which no one can accurately predict, hence the message is to always be prepared for them.