By Brian Nelson, CFA
Intrinsic value represents the conclusion to any and all stock research: What is the company worth? DCF valuation captures the expectations of a firm’s competitive advantages, growth prospects, strategic endeavors, and any other qualitative factor. No other process does this. Putting to numbers a plethora of advanced fundamental items in arriving at a fair value estimate is the cornerstone–and the most critical component–of any stock research analysis. Without an in-depth intrinsic-value assessment, research is but a story that has no ending. — Brian Nelson, President, Valuentum Securities, 2011
Having worked on the buyside for a top-performing small-capitalization fund and on the independent/sell-side for a number of years in methodology development and optimization, I can tell you with absolute 100% certainty that what you watch on TV is not investing. It is entertainment. Turn off the TV…please.
For an experienced professional, it is unbearable to watch the business programs on the boob tube. Unbearable. Yet, I forced myself to put in 4 hours of business TV today, just to continue to test my thesis on business news. Nothing against the newscasters and guests—after all, I am often one of them—but on live TV, it is nearly impossible to get to the correct questions, let alone get to the right answers. What you’ll find is that investing success is not necessarily a result of knowledge of the companies, but instead it is the result of the process behind selecting companies. There wasn’t one piece of informative conclusions presented in all 4 hours of watching.
One of the biggest dings I have against the popular business media is that they are just reporting news. I talked about this extensively in a recent video, but the most important question in stock investing is not the news but how the news impacts the cash flows of the business, and more directly the valuation equation (and how that valuation estimate compares to the stock price). Without a doubt, the valuation equation is the primary consideration with respect to what makes a good or bad investment. I’m not sure there is room for disagreement on this one: after all, the valuation outcome is the result of any and all analysis.
For example, would USG (USG) be attractive if it were trading at $50 per share? Nope. But is the company a very interesting idea at current pricing levels, trading at such a large discount to intrinsic value? Absolutely. USG is near the top of our list for potential additions to the Best Ideas portfolio. The company recently garnered a rating of a 9 (equivalent to a “we’d consider buying rating”), and you may be getting an email transaction alert on the company with respect to addition to the Best Ideas portfolio.
Okay then, what are the right types of questions to ask?
Instead of asking, does the company have an economic moat, ask: is the company’s economic moat already factored into the stock price? Instead of asking whether the company has good management, ask: is the management team’s business prowess already reflected in the current stock price? Instead of asking whether the company has fantastic growth prospects, ask: is the company’s fantastic growth already factored into the stock price? These are the right questions.
On the boob tube, you may only hear about a company’s economic moat, management, or its growth prospects. You may hear thoughts about the next product launch and just about anything else. But what you don’t hear about is whether these items are already priced into the stock. Did the newscasters open their books up for analysis? Did the analysts show you every assumption behind the fair value estimate? Nope. So, how in the world can the business news be valuable? Quite simply: it’s not. It’s entertainment.
Most investors know what some of the key drivers behind a business. But it is not a focus on assessing the key drivers themselves, but assessing whether the key drivers are already factored into the stock price that is important. Knowing the right questions to ask and having the right perspective makes all the difference in the world in investing.
What I’m talking about more specifically is the core difference between buying a good company and buying a good stock. There are a lot of good companies that are also good stocks, but not all good companies are good stocks. It’s important to make this very important distinction. Everyone wants good stocks. Nobody wants to hold a company that is a bad stock.
A company’s competitive advantages, management team, and growth prospects do not make a company a good investment. A good investment only occurs if the discounted cash flows driven by a company’s competitive advantages, management oversight and growth potential are not properly reflected in the stock price. If the intrinsic value is greater than a firm’s fair value estimate (i.e. if the company is trading below its fair value range in the Valuentum reports) the company is worth considering. If the firm is also undervalued on a relative basis and is showing pricing strength, then it is a very attractive idea. We’d call this particular stock a Valuentum stock.
The best types of investing services are the one that most accurately reflect a company’s qualitative considerations into a fair value estimate that can then be compared to the stock price, in our view. The fair value estimate is the answer to all the questions that can be asked about a stock. The fair value estimate is not one factor behind the investment consideration—it should be the first factor behind the investment decision. You’re not going to get the reasoning behind intrinsic value estimates from the business news on TV. Turn off the TV!
Did you know?
Some members just use our service for the robust intrinsic value methodology we perform. This is one of the key benefits of multi-faceted research and the transparency behind the Valuentum process. Don’t just settle for an idea. Demand robust intrinsic value analysis so you can compare price versus value.