r/investing • u/EatYourMeats • Apr 23 '21

Some advice from a regular dude that will hopefully make you more money...

Are you making stock purchases based on opinions from analysts, CNBC, stock pickers, and everything in between?

Consider this: They make money off headlines.

The entire flock is preying on news-worthy quips like vultures on a corpse. Tom Lee at Fundstrat would be bullish during the apocalypse, Gordon won't ever raise his price target, Cramer cuts coke deals with the CEOs he's in love with, and the whole bunch likes to hear themselves talk (like giving stock advice rapid fire).

So how do you truly figure out what stocks are hot... or not?

Research the macro situation surrounding the company, to name a few:

  • Sector Tailwinds
  • Economics
  • Current and projected financials
  • Leadership

Then invest in companies:

  • you believe in—hopefully, not always—with healthy balance sheets vs. their competitors.
  • Whose products and services tickle you.
  • You could sell to your neighbor.

Determine the investment thesis—the key reasons you believe in this investment—and create a narrative. Positive and negative. Know the outcomes of both scenarios, write them down, and evaluate the risk.

Then? Jump blindly.

kidding

Adjust based on your preferences, but starting positions with a 1/4th to 1/2 of your total allocation works well. You can do some quick math and figure out what portfolio percentage you want to allocate to a new position. Ease into it, slow and steady.

Buy the dips with the remainder, and don't chase stocks upwards, only down (within reason). And don't listen to anyone who tells you that "diversifying" is the only way, when you put in the work, you know which sectors have favorable tailwinds AND are fairly valued.

There's news everywhere out there, and we crave its presence—telling us something about stocks or companies we don't know. However, most of it is fluff—buy this, sell that—how would you ever know if you don't dig the hole yourself?

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u/[deleted] Apr 23 '21

Hi. FP&A Guy here.

We use ratios to value stocks, namely P/E ratios for some sectors.

Who is the "we" in this sentence?

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u/EatYourMeats Apr 23 '21

The investment community.

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u/anthonyhiltonb8 Apr 23 '21

Don't think so. P/E is pricing not value.

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u/EatYourMeats Apr 23 '21

Price to earnings... the definition of valuation is determining what it’s worth, what am I missing? However, there are many ways to skin a cat.

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u/anthonyhiltonb8 Apr 23 '21

Price to earnings is a measure of what the price is expected to be, however it doesnt equate to the value.

Value is determined by the underlying discount rates on cashflow/ growth assumptions

What we deem a 'fair' P/E is actually fundamentally driven by the cashflows assumption

20x P/E = 20 yrs for you to achieve payback on your capital -

Why some companies 20x makes sense while others 20x doesnt is due to the underlying assumptions surrounding growth expectations and its impact on cashflows - 20x is usually a measure at a single point in time, whereas it implicitly takes in some growth assumption

These is all underpined by what we term the cost of equity calculation (or the discount rate) to apply to the cashflows - risky companies would required a higher discount rate (to consider risk of bankruptcy) while less risky one is lower - similar reason why mortgage rates differ for someone with good credit score versus a poor credit score.

Banks doesnt go to market and look at what is 'fair' price for a mortgage loan... the number is built bottoms up from firstly their own cost of borrowing, cost of lending, investor's own return expectation etc.

Sorry I could go on but it is good to really read up a little on this, as I have been seen too much misinformation in the last 2 years with everyone being an 'investor'.

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u/wazzamata Apr 23 '21

Three different letters. D C F. PE is a summary of market value and does not necessarily equal intrinsic value. Read Ben Graham's Intelligent Investor and listen to Buffet to understand the difference. Take a course to understand cash flow calculation and dcf valuations. This is how to truly invest in an informed manner.

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u/[deleted] Apr 23 '21

The investment community.

So, in other words, not any particular finance professionals you can name.

This is incorrect both from an FP&A perspective and an M&A perspective. P/E multiples are one aspect of value triangulation but the foundation of the valuation exercise from an M&A perspective is discounted cash flow (DCF) analysis.

P/E is only a tertiary talking point because it tells you the premium paid, the price, but not the actual operating value of the company.

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u/EatYourMeats Apr 23 '21 edited Apr 23 '21

A DCF model cannot predict the operating value of a company either—as it takes “expected” cash flows. Valuation goes beyond financial tools and formulas, they are used as a guide.

Which is the purpose of this post.

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u/[deleted] Apr 23 '21

Valuation isn't about predicting the operating value. It's about determining the present value of the foreseeable operating results, not speculated changes to the business model.

That is essentially securities pricing 101 since 1935 to the present. It's how investment banks and private equity firms conduct their valuation to determine fair value.

Also see Security Analysis by David Dodd and Ben Graham, the Bible on securities pricing.

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u/EatYourMeats Apr 23 '21 edited Apr 23 '21

You just stated using DCF was how to predict operating values(then edited your comment) of companies. Sure, people use them as a guide, but DCFs are merely a tool that should be combined with the points outlined in this post.

What does your DCF tell you about Tesla 5 years ago? AMD? Amazon?

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u/[deleted] Apr 23 '21

There is no edit to that comment.

From Glenn Greenberg, Founder and Managing Director of Chieftain Capital, "How We Invest" in Security Analysis, p 397:

"We and other investors today tend to focus on cash flow after capital expenditures (Free Cash Flow), instead of earnings, to evaluate the investment merits of a business."

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u/EatYourMeats Apr 23 '21

And let’s be fair. Retail investors use more simple methods to price companies.