Paying Up Rarely Pays off By paying close attention to the price you pay for a stock, you minimize your speculative risk, which helps maximize your total return. No one knows what a stocks speculative return will be over the next year – or even 10 years- but we can make pretty educated guesses about the investment returns. If you find great companies, value them carefully, and purchase them only at a discount to a reasonable valuation estimate, you’ll be fairly well insulated against the vicissitudes of market emotion.
Careful attention to valuation lessens the risk that something truly unknown- what other investors will pay for our asset in future –will hurt the return of our portfolio. As investors, we can diligently work to identify wonderful businesses, but we can’t predict how other market participants will value stocks, so we shouldn’t try.
Being picky about valuation isn’t fun. It means letting many pitches go by and watching many stocks run – stocks that never met your strict valuation criteria. But when its done properly, disciplined valuation also greatly increases your batting average – the number of stocks you pick that do well versus the number that do poorly – and it also limits the odds of a real blow-up damaging your portfolio.
Using Price multiples wisely
Our first stop in learning how to value stocks is traditional measures such as the price-to-sales (P/S) or price-to-earnings P/E ratios. Although these measures do have some advantages – for example, they are very easy to compute and use – they also have some significant pitfalls that can lead the unwary investor to fuzzy conclusions
“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” — Ben Graham It occurs to me that the typical individual who buys and sells common stocks makes little or no distinction between the concepts of speculation versus investment. Instead they […]
The returns of investing in an individual stock or in the entire stock market are determined by these three factors: The Sources of Investment 1. Business growth If we look at a particular business, the value of the business is determined by how much money this business can make. The growth in the value […]
1. “The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” Warren Buffett 2. “A business that makes nothing but money is a poor business.” Henry Ford […]