Keeping Stock Valuations Simple

Keeping Stock Valuations Simple
(CC) Investment Masters Class - With permission from copyright holder

Keeping Stock Valuations Simple by Investment Master Class

“In 44 years of Wall Street experience and study I have never seen dependable calculations made about common stock values, or related investment policies, that went beyond simple arithmetic or the most elementary algebra.  Whenever calculus is brought in, or higher algebra, you could take it as a warning signal that the operator was trying to substitute theory for experience” Ben Graham

Simplicity or singleness of approach is a greatly underestimated factor of market success.  As soon as the attempt is made to watch a multiplicity of factors even though each one has some element to justify it, one is only too likely to become lost in a maze of contradictory implications.. the various factors involved may be so conflicting that the conclusion finally drawn is no better than a snap judgement would have been”  Garfield Drew, 1941

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“The reason our ideas haven’t spread faster is they’re too simple.” Charlie Munger

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“Any attempt to value businesses with precision will yield values that are precisely inaccurate” Seth Klarman

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“We’d argue there’s a lot of false precision in our business and that the best investments don’t require a financial model that goes out five significant digits” Ira Rothberg

"We never sit down, run the numbers out and discount them back to net present value ... The decision should be obvious"  Charlie Munger

“It is better to be approximately right, than precisely wrong” Warren Buffett

"There's no such thing as precise intrinsic value" Mohnish Pabrai

"There are so many factors involved that it is never wise to attempt to judge intrinsic value to the last eighth or even point" Phil Fisher

"Given that the future is inherently uncertain, we do not believe the value of any business can be known with certainty at a given point in time, so our aim is to be generally right as opposed to precisely wrong."  Wally Weitz

"It is important to understand that intrinsic value is not an exact figure, but a range that is based on your assumptions" Jean-Marie Eveillard

"The cost of obsessing on precision is to often miss the forest for the trees" Frank Martin

“Having more information doesn’t necessarily improve decision-making. We know from studies of horse racing than when handicappers receive more information about horses and riders, they become proportionately more confident even though they are no more likely to pick the winner. When analysts have too much data, there’s a danger they won’t see the wood for the trees” Marathon Asset Management

"I’m reminded of a study which showed that as the number of variables requiring analysis increase, the odds of success decline, yet the confidence of participants soar due to extensive time and energy invested." Allan Mecham

“Using precise numbers is, in fact, foolish: working with a range of possibilities is the better approach” Warren Buffett

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“When we think about intrinsic value, it is always a rough guess. In my mind, if I throw out a number to you such as “I think intrinsic value for this stock is 100,” What I’m really saying, and the way we internally use that statement is “it’s 100, give or take 10% to 15%. It might be 85, it might be 115” It’s 100 with implied error bars around the statement." Ken Shubin Stein

“Charlie and I admit that we feel confident in estimating intrinsic value for only a portion of traded equities and then only when we employ a range of values, rather than some pseudo-precise figure” Warren Buffett

“It is easy to confuse the capability to make precise forecasts with the ability to make accurate ones” Seth Klarman

“I’ve found most of our investments I can summarize in a sentence” Glenn Greenberg

" The truly big investment idea can usually be explained in a short paragraph" Warren Buffett

“Keep it simple. Your thesis should be on the back of a postcard if it’s right.” Bruce Berkowitz

"When I invest in a company, I like to be able to explain it to my children in a single sentence." Robert Vinali

“In depth information does not mean indepth profits” Dave Dreman

"In general, I haven't run spreadsheets and I find that, if there is a need to run a spreadsheet, that is a red flag to take a pass" Mohnish Pabrai

“Never invest in any idea you can't illustrate with a crayon” Peter Lynch

“Conservative forecasts can be more easily met or exceeded. Investors are well advised to make only conservative predictions and then invest only at a substantial discount from the valuations derived therefrom.” Seth Klarman

“I think analysts spend too much time building models and being myopic in they don’t spend enough time trying to take a broader perspective” Michael Karsch

“Businesses, unlike debt instruments, do not have contractual cash flows. As a result, they cannot be precisely valued as bonds” James Montier

“The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. It need only establish that the value is adequate” Ben Graham

“Several difficulties confront growth-orientated investors. First such investors frequently demonstrate higher confidence in their ability to predict the future than warranted”. Seth Klarman

“An unresolved contradiction exists: to perform present value analysis, you must predict the future, yet the future is not reliably predictable” Seth Klarman.

“We can’t compensate what we can’t predict with a higher discount rate”  Peter Bevelin

"We try to deal with things about which we are quite certain. You can’t compensate for risk by using a high discount rate.” Warren Buffett

“If modest changes in assumptions cause a substantial change in NPV, investors would be prudent to exercise caution in employing this method of valuation” Seth Klarman

“Investment experts continue to be convinced that their major problems could have been handled if only those extra few necessary facts had been available. They thus tend to overload themselves with information, which usually does not improve their decisions but only makes them more confident and more vulnerable to serious errors”. Dave Dreman

“The value of in-depth fundamental analysis is subject to diminishing marginal returns” Seth Klarman

“The most elegant valuation spreadsheet in the world won’t be worth much if you don’t understand and account for the bigger-picture influence on a company's business” David Iben

"I think it is not how sophisticated you are in your valuation model, but how well you know the business and how well you assess its competitive advantage. This cannot be modelled mathematically, but has more to do with the investor's own experience" Francisco Garcia Parames

"We try to avoid investing in businesses where an exogenous event can completely rewrite your spreadsheet." Gregg Powers

"There are only a few things you have to get right about a company for it to be successful investment. Our view is that if you can get 85% of the way there by answering the big questions, don't waste your time on the last 15% because the marginal utility isn't worth it" Steve Morrow

“A key rule in investing is that you don’t necessarily need to understand a lot of different things at any given time, but you need to understand the one thing that really matters” Dan Loeb

"I always try to use a no brainer test where I should be able to write down within a paragraph exactly why a particular investment will work out and what are the factors that will drive the result.  I write a paragraph and keep it.  If I cannot articulate in that type of format, then I leave it alone"  Mohnish Pabrai

"We don’t use DCF – there are too many variables." Thomas Schrager

"If you can't figure it out on the back of an envelope, a big spreadsheet model is not going to give you the right answer"  William Martin

"We’ve always done very well when we can use sixth-grade math on the back of a postcard to show how inexpensive something is relative to its free cash.  Once we start getting more sophisticated – trying to prove something rather than see if we can disprove it by killing the business – we get into trouble."  Bruce Berkowitz

"Calculations of intrinsic value, though all-important, are necessarily imprecise and often seriously wrong.  The more uncertain the future of the business, the more possibility there is that the calculation will be wildly off-base." Warren Buffett

"Historical experience teaches that valuation is not an exact science; the variability of multiples even over short periods makes something of a mockery of the idea of fixed target prices.  It is far more realistic to have a range in mind for what a business can be worth"  Marathon Asset Management

"Spreadsheets make everything look linear and controlled, but the real world oscillates, overshoots, collapses and rebounds.  A company with operational and financial flexibility - what we mean by staying power - is able to exercise options that are quite valuable at different points in the cycle.  Without the firm handle on that flexibility that credit analysis provides, we'd argue you can't fully understand the wealth creation process as an equity investor"  Mitchell Julis

"I use a very simple calculator: plus, minus, divide, multiply - that's it"  Francisco Garcia Parames

"A person infatuated with measurements, who has his head stuck in the sand of the balance sheet, is not likely to succeed" Peter Lynch

"The simpler the investment thesis, in general, the more money you'll make"  Mohnish Pabrai

"Avoid over-relying on numbers and models. Investors often feel comfortable with numbers and models because they appear definitive. However, they can be misleading because they often are based on historical data that may not be repeatable or are based on assumptions that may not prove valid.  We need numbers and models, but their utility should be paired with judgment and  common sense" Ed Wachenheim

"When we analyze a business, we pay close attention to the qualitative and intangible variables –such factors are often difficult to ‘model’. We are uneasy with fancy numerical models and broad diversification, which have almost ubiquitous acceptance by the high priests of modern finance. In both cases we believe one is susceptible to gaining a false sense of security, which can result in mental slothfulness and neglect. In the case of models, analysts tend to overweight what can be measured in numerical form, even when the key variable(s) cannot easily be expressed in neat, crisp numbers.  The ‘model’ behind our largest investment required nothing more than sixth grade math, and a napkin – not a sophisticated spreadsheet capable of more numbers than I’m capable of counting." Allan Mecham

"While we can run spreadsheets with the best of them, we really emphasize understanding the qualitative factors that drive the numbers. Market shares. Competitive advantages. The secular and cyclical impacts on the industry. Management’s skill in allocating capital. The goal is to identify companies in which we have a great deal of confidence that their values are going to continue to compound as we own them." C.T Fitzpatrick

"A good analysis of where a company is headed demands a look at qualitative factors, those touchy-feely, squishy, from-the-gut factors that are ignored despite the fact that they often determine the company's fate"  Marianne Jennings

“Warren often talks about these discounted cash flows, but I’ve never seen him do one.   If it isn’t perfectly obvious that it’s going to work out well if you do the calculation, then he tends to go on to the next idea.” Charlie Munger

"In general I would say it is better not to have a whole bunch of precise DCF's going out 15 years and then coming up with some value.  You are better off saying the bank's at half book value.  For various reasons, the book value is solid.  For various reasons, book value will grow and that long term it will trade at the premium book value.  Then, leave it at that".  Mohnish Pabrai

"When it comes to using discounted cash flows I have a firm view.  I was reading some work and it used discounted cash flows and some sophisticated stuff and I am not good enough at math to be able to work out that kind of stuff and I have sort of come back in my simple way to Graham who said it you can't add it, subtract it, multiply or divide it, then the math is too heavy.  And the problem with this kind of cash flow is that it is simply a projection and, whatever the rate you choose to use, that will almost certainly shift on you.  So you are trying to make two imprecise variables into a precise tool and that could get you into a whole mess of trouble" Peter Cundill

"We don't do much discounted cash flow analysis because it gives you an impression of worth down to the decimal point, which does not require being so precise" Jean-Marie Eveillard

"Investment models encourage anchoring. Most models are calibrated to produce a current value for a company within a reasonable range of the current price. Another wrinkle is the discount rates. If you don’t accept that historical volatility (beta) is a good measure of risk (which we do not), then it’s not clear how to calculate the appropriate discount rate. At Marathon, we believe that detailed forecasting adds little value".   Marathon Asset Management

"I agree with Warren to keep is simple and not use higher mathematics in your analysis" Walter Schloss

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"Going for too much certainty can hold you back – there is no certainty. A lot of it is weighing probability, a lot is judgement, and a lot less is number crunching and multi-variable modelling. I have seen so many cases where there is a complex model that is exactly wrong.  This focus on a model may cause you to move away from thinking about the competitive advantages of the business. Then you are making decisions based on all these numbers rather than thinking about whether this is one of the ten businesses that you would like to own." Glenn Greenberg

"In my mind, if things cannot be explained simply, that is a signal that you should start to dig because things in general shouldn’t be convoluted or complex. When someone explains a business or an investment thesis to me, and it can’t be explained to a 10th grader in a paragraph or less, that’s a bad sign." Marc Cohodes

“It’s not about the numbers.  For most investments the factors that will drive long term success don’t have much to do with spreadsheets.  They have to do with something other, either understanding human nature or understanding nuances about how certain aspects of how things work rather than running spreadsheets”  Mohnish Pabrai

"In my life there are not many questions I can't properly deal with using my $40 adding machine and dog-eared compound interest table" Charlie Munger

"I revise models frequently because my initial models rarely are close to being accurate. Usually, they are no better than directional.    But they usually do lead me in the right direction, and, importantly the process of constructing a model forces me to consider and weigh the central fundamentals of a company that will determine the company's future value." Ed Wachenheim

"I'm very much a believer in Peter Lynch's old dictum that a good stock idea can be written on the back of a matchbox cover"  Shad Rowe

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