Hempton on Valuation Analysis

Here’s a very good post by John Hempton on valuation analysis. Here’s a key bit:

This is a general quality of investment analysis. Proper valuations are far more art than science. DCF valuations – especially of something growing near or above the discount rate are famously sensitive to assumptions. The right comparison is to the Hubble Telescope: move direction a fraction of a degree and you wind up in another galaxy.

By contrast there are some things for which a proper valuation should be done and can be done.

If you own a regulated utility what you really own is a regulated series of cash flows with regulatory risk around them.

An accurate valuation is part-and-parcel of the analysis – because it delineates what you own.

The battle here is to work out what the salient details are. Sometimes they are whether young people will continue drinking Red Bull. Sometimes they are working out a technological change.

In rare cases they are working out valuation.

Mostly valuation is simply about bounding a margin of safety. And most of that involves understanding the business anyway.

This is a reason why I tell investors not to rely on stock screeners. The big winners in your portfolio won’t be stocks that go from a 13 P/E to a 17 P/E. Rather they’ll be ones that increase their “E” by 10 fold.

Posted by on January 3rd, 2017 at 12:32 pm

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.