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.

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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.

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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


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