GV, I think you make an excellent point. Presumably, we invest in individual companies because we believe that the market is inefficient to some extent.
I have used a "reality check" kind of model. Basically, I ask myself what earnings would be required to support the current price of a stock if the company were mature. For example, suppose that XYZ has a forward P/E of 100, and suppose, further, that if the company were mature (and by that I mean that its growth would be equal to the growth of the general economy) it would have a P/E of say 10. That means that it would need to expand its earnings 10-fold to support the current price of the stock. I then ask myself whether the potential market is large enough to support that assumption, and if so, what is a reasonable trajectory for attaining that result. Additionally, I ask myself how large is the potential market share at the time XYZ becomes mature, and what will be the projected earnings at that time.
This method is clearly not consistent with the way the market prices securities. For example, I have studied AMZN to a fare-thee-well and come to the conclusion that even if all of the rosy profit margin predictions come to pass, the potential market (sales) is not large enough to support the current valuation of the stock. Of course, retailers are fairly easy to analyze in this context (and AMZN is a retailer) -- tech stocks are a horse of a different color because recurring innovations preclude maturity.
TTFN,
CTC |
