Richard’s Observation of the fallacy and trap of value investors:
I have noticed that there are too many retail investors that are so engrossed in the numbers of value and price and finding the ‘holy grail’ of valuation and the exact number of fair value and the exact hit of margin of safety.., that they have missed the underlying principles of why the valuation came to be in the first place.
1) Where does valuation come from? Earnings
2) Where does earnings come from? The business operations itself
3) How is the business being run? By the employees and founders.
4) How did the founder manage to set up and run the operations well? By luck, timing, foresight (By a gust of industry cyclical tailwind.)
By looking at valuation first and the regular use of stock screeners such as Morningstar or Bloomberg, we tend to get stuck in the trap of looking and historical values that represents ‘already happened’ stuff, and the price often reflects the value within, therefore the projected returns can be there, but are more often than not, a reflection of the market indexes and inflation.
What you should be looking for is the ‘hidden edge’, the ‘second level idea’, which may seem obvious to some people when they finally get it, but more often than not it eludes most people who typically look at the Price to Earnings or Price to Book ratios only.
There are many better approaches towards investing, don’t get stuck in the commonly ‘sold’ approach of the holy grail of valuation.
In Part 2 I will talk about the various multi-tier approaches that successful business investors now use to unlock value in the current markets, namely “The Smell” (Business Model), “The Tailwind” (Industry Tailwind), “Gold Digger” (Market Cycles), “Mr. Gecko” (Activist Investing).
Stay tuned for our next updates!