If I were asked to characterize my investment philosophy, I would describe myself an investor who believes in value, but I would be lying if I told you that it has always come easily or naturally. My faith in value is tested constantly, not only by the recognition that there is far more that I don't know about value than I do, but also by the market, which seems to have an uncanny ability to sense my doubts and find ways to probe them.
- Keep the faith that your estimate of value is correct, that the market is wrong and that the market will correct its mistakes within your time horizon. That may be what every value investing bible suggests, but your righteousness comes with no guarantees of profits.
- Abandon your belief in value and play the pricing game openly, either because your faith was never strong in the first place or because you are being judged (by your bosses, clients and peers) on your success as a trader, not an investor.
- Preserve the value illusion and look for "intrinsic" ways to justify the price, using one of at least three methods. The first is to tweak your value metrics, until you get the answer you want. Thus, if the stock looks expensive, based on PE ratios, my post on the pricing of social media companies, you will eventually find a metric that will make your stock look cheap. The second is to claim to do a discounted cash flow valuation, paying no heed to internal consistency or valuation first principles, making more in name than in spirit. The third is to use buzzwords, with sufficient power to explain away the difference between the price and the value. / and if it still looks expensive, you move on to revenue multiples. As I argued in
4. Growth potential
Links (perhaps helpful, perhaps not): (1) A spreadsheet to value growth
3. Strategic considerations
What it really means: A billion plus people, with rising incomes, is a very large market and any company that succeeds in this market should be able to generate large revenues and perhaps large profits.
- The Buzzword Count Proposition: My exposure to both and buzzwords leads me to conclude that there is a negative correlation between buzzword usage and valuation quality. In other words, the more an analyst uses words like real options, disruption and China in talking about a company, the less substance there seems to be the actual research.
- The Buzzword Swarm Proposition: The most dangerous challenge that you will face as investor will be when multiple buzzwords come together in the same news story. We have two IPOs coming up in the near future, Alibaba and Weibo, which will qualify under multiple buzzwords (strategic, growth potential and China at the minimum) and will undoubtedly be priced to deliver multiple premiums.