Hi Thomas, Yup, count me amongst the lazy :)
That's one of the best things about being in the market, is that a whole bunch of professionals are out there putting your capital to work.
Indeed, in not so many weeks I will have been on vacation for a year. It is rather pleasant.
I sense from your post a slight misinterpretation of my stance. The highest frequency with which I even contemplate tinkering with my portfolio is quarterly. The frequency of action... well, the last adjustment was more than a year ago and counting. There are people whose definition of "Long Term" is shorter than the interval over which I make and execute decisions. Phlegmatic, sloth-like, glacial... choose an adjective. I prefer "extremely careful".
Not risk averse however. Just careful in adopting risk and choosing expected rewards.
Volatility is not what worries me about a stock. Shouldn't one expect over the long term to see reasonable fluctuations? What worries me is buying high and having to sell low. Or buying low and selling lower. Frankly, that worries me a lot. Been there. Done that.
So your comment about "only one" purchase decision and "only one" sale decision is extremely appropriate. It is vitally important to get each of these correct with a LTBH position, because barring an exogenous event, you really only have one of each. Two conclusions therefore: (a) it's important to appropriately "time" entry if you only have one crack at it, and similarly to "time" exit; plus (b) if a terribly appropriate exit point appears, it is worthwhile answering the door when opportunity knocks. Which is hard to do if it's not important to know what knocking sounds like.
Not talking swing trading. Or picking up the +/- 20% moves like we just saw QCOM take. Those happen and then they are over with. I'm talking watching while I think XYZ should be $xx, and waiting. Sometimes for a few years. Which isn't very long in the LT scheme of things.
As for a method of valuation? I think I went through this before.
Let's try a simple calculation. First question: What economic value is The Company likely to attract towards itself in quantitative dollar terms over the next five years? Over the following five years, and over the following five years? Economic value means profits. Real profits that could get distributed back to shareholders. Interest on investments is still profit. Investments that vanish are negative profit. Depreciation is neither positive or negative. But the cost of acquiring the asset in the first place is negative profit. Which includes acquisition of businesses and inventory and so on. Even if it gets pulverized later. No need to be precise here. An estimate is good enough. Take a recent few quarterly reports, figure out what is profit and what isn't, add it up. Basicaly profit is GAAP Earnings plus non-cash charges against earnings minus capital investments in plant, property, equipment (and for knowledge businesses, acquisition of technology, licenses and know-how). Sound very similar to DCF? That shouldn't be surprising.
A warning: money that accrues to the company in any way connected to the process of printing more shares during ordinary operations must be subtracted from reported profits that include it. All of it. For secondary issues and warrants and so on, this is fairly direct. For stock options, one must factor out the infusion of exercise price into the company's cash account AND the tax benefit, AND the value that shareholders end up paying to employees.
Second question: what do we expect the following figures to be in the five, ten and fifteen year time frames: Revenues, Earnings before Taxes, Cash and cash equivalents net of liabilities, Shareholder equity, cash flow, shares outstanding. Are these reasonable (e.g. as a percent of GDP, as a percentage of the cost base of their customers), consistent (e.g. as a percent of revenue), achievable (as in have they or anyone else achieved something similar before?) and consistent with our answer to question 1? Reiterate question #1 and #2 until aligned.
Third question: We can not be "sure" that our figures will correctly predict the future. Indeed we had better expect that the future will hold answers that turn out higher or lower than our estimate. That doesn't mean it's a worthless exercise. We must start somewhere. Our job isn't to be right, it's to be close enough for comfort. And to invest with an expectation of profit that matches the degree of risk we undertake. If we are absolutely certain then we should be demanding less margin for profit because we entertain lower risk of loss. If we are uncertain, then we need to embrace more profit potential to make up for the odds of being wrong... and so on. So let's estimate the accuracy of our estimate! What are the chances that we are low by a factor of two (low%)? High by a factor of two (high%), and within this 4fold envelope (mid%). Reiterate questions #1 and #2 and #3 and harden your opinion of the company until (mid%) > 50%.
Check: Can you honestly defend your answers to #1, #2 and #3 to an individual who is (a) not optimistic about the prospects for The Company, and (b) not an idiot? This does not mean you must agree. Just that you have not unconsciously missed something important or fallen into the trap of unconsciously choosing numbers that lead to the answer you think should be right. If you can't find someone who matches these criteria then your internal alarms should go off big time.
First cut at valuation with the chain saw. Take the three numbers from question #1. Convert each into five separate years, plug the fifteen numbers into an excel spreadsheet, and discount profits back to present value. Sum.
Divide this figure by the number of shares outstanding and multiply by your mid% risk. Voila. You have just calculated your own approximate risk-weighted fair price per share. In present dollars.
Now, odds are that you and the market disagree. Possibly violently. The next question to ask is "why", and "how long do I expect this divergence of opinion to last"?
Usually there is a very good answer, and it will be based almost entirely on macro-economic trends because these are the only things that affect so many people. Which is why folks observe that macro events seem to play a role in stock price. Because it is merely "divergence", one will also correctly note that a company's own results also count, so that a company can be "up" in a "down" market and vice versa.
Anyway, then one is left hypothesizing how long the divergence might last and so on. There is no need to sell whenever your price looks lower than market. Or vice versa. My experience has been that divergence can last for a long time. Sometimes my error, sometimes the market is lofty or depressed for a very long time. The feedback cycle is long. I spent about five years before figuring out enough to be confident. Still learning. And I don't touch companies if I can't figure out a fair price I feel comfortable with.
The other thing to note is very specific to GG. The risk of a tornado forming is much higher in the bowling alley then it is early in the tornado than it is as it is clearly defined. And folks naturally over-estimate the potential for exponential growth to go on forever... so late in the tornado one may have an implied certainty of future profits of greater than 100% (that is, an over-estimation). The net effect confirms Moore's hypothesis that the market is likely to under-price a gorilla early on (factoring in a lot of risk) and then over price it later (factoring in excess confidence). This actually confirms his buy/sell strategy. However, this is in general. Nothing prevents the market from anticipating this effect and over-compensating, and as pleasurable as it might seem, it is perhaps naive to assume that we of this thread are the only smart folks and the other folks out there who make up the market are dumber.
Your question: "Not having found it yet, the question is what one does until it is found" is extremely relevant.
I would hire a professional money manager who is paid a fraction of what you earn (not on a fraction of your portfolio value)! And then go on a vacation from dabbling in the market. While learning, continue the process of identifying good companies. Let him or her know you like company x or company y or company z but tell them in no uncertain terms that you haven't got the foggiest clue how much they are worth. But one thing I wouldn't do is put my cash arbitrarily in the hands of an industry that is designed to part me and my money.
And I would spend a lot more time testing valuation models proffered to me than picking companies that may or may not be good things to invest in. The absence of one renders the other to be an academic exercise at best.
Sorry if this was a long post...
John. |
