Thread by @jpr007

REAL EQUITY INVESTING

Investment analysts and money investors frequently make many different kinds of mistakes when valuing companies as Real Equity Investments

These include :

And there are more, although the others are mostly secondary errors rather than primary errors

Now let's take a quick look at each point

1. INVESTING BASED ON THE COMPANY'S CURRENT PERFORMANCE

Real Equity Investing is all about where the company will be in the future, not in the present

This is most fundamental

Without a future view any activity with the stock is just trading and not investing

2. NOT LOOKING OUT FAR ENOUGH INTO THE FUTURE

Real Equity Investing should be about looking to make multiple returns on your money, preferably at least 4x to 10x

- and this kind of fundamental value growth is rarely achieved in less than 5-10 years

3. LOOKING OUT TOO FAR INTO THE FUTURE

High growth rates do not last forever

Eventually they cool down, and when they do the growth in value must decline too

- which means that your investment growth eventually declines below some threshold value compared to your alternatives

4. UNDERESTIMATING THE FUTURE

The future is very difficult to predict, leading many analysts to be very conservative in their estimates and only raising their expectations as reality becomes glaringly obvious

5. OVERESTIMATING THE FUTURE

Even though the future is very difficult to predict, some analysts like to be very bold or unconstrained by reality in making their estimates

- taking credit if their optimistic outlook comes home

- and quietly ignoring the cases that don't

6. USING TOO SIMPLE MODELS

Simple linear extensions of current performance will rarely provide an intelligent perspective on the future

There should be an understanding of the industry context, the unit volume drivers, and the revenue pricing

And there should be an intelligent understanding of the company's cost structure at least in terms of Gross Margin and primary Overhead Costs

Internal Cash Flows to fund the business should also be understood

7. USING TOO COMPLEX MODELS

Many analysts attempt to take this modeling of a business into far too much detail, creating an illusion of precision while often getting lost in the numbers

And they misunderstand the actual economic events that an ordinary investor is exposed to

A Real Equity Investor is only exposed to two meaningful events :

- the price he Buys at

- the price he Sells at

The first of these requires no analysis

The second is best predicted by simply calculating the future Stock Price by estimating the future Market Capitalization

And this is most simply done by multiplying a mature future Net Income by a reasonable P/E Multiple that reflects such maturity of the business

8. BUYING TOO HIGH

If you do not know the future value of the business, you are highly likely to overpay for it today

If you overestimate the future value of the business, you are certainly positioning yourself to overpay for it today

Even if you correctly estimate the future value of the business, you should always want to buy its shares at the lowest possible price, which would preferably be some fraction of your expected present value

Buy Low

Always be a Bargain Hunter

9. USING THE WRONG DISCOUNT RATE

Discounting a future value back to the present is a very handy tool

But the Discount Rate that you use then becomes a direct predictor of the returns that you should expect

If you only want 5% per annum returns, then use 5% as your Discount Rate

- it will give you +63% over 10 years

If you only want 10% per annum returns, then use 10% as your Discount Rate

- it will give you 2.6x over 10 years

But IMHO if you want to be a Real Equity Investor, you should be looking for at least 15% per annum returns

Then you must use 15% as your Discount Rate

- and it will give you 4.0x over 10 years