Valuation: As easy as 1-2-3

Published on 08/03/23 | Saurav Sen | 845 Words

The BuyGist:

  • We send out The Buy Scan at least once a week.
  • We cover the most pertinent (and trending) topics in investing.
  • We rely heavily on our primary valuation tool - The Buycaster - to get actionable insights.
  • We hope that each Buy Scan provides at least one salient insight.

Rationality = Average of Sanity & Safety

The whole point of the Buycaster is to make valuation "as simple as possible but no simpler". See the Apple example below.
The Buycaster is meant to be used either as a first cut or as a last cut analysis tool. The cut that comes before or after the Buycaster, depending on how you use it, is good old-fashioned subjective analysis of a company’s competitive advantage, management strategy yada yada yada…we can never replace that soft stuff. But numbers? Yes, we can do the heavy lifting! But it's got to be done right - in a way that works, that spots that elusive mis-priced, long-term bet in the market.
I admit that the Buycaster is an unconventional valuation tool. For starters, it doesn’t give much importance to the word “valuation”. The basic premise of the Buycaster is that “intrinsic value” is unknowable. It’s an ever-changing quantity. So, why build fancy, multi-tabbed, time-consuming, macro-powered spreadsheets just to be wrong…to be fair, very precisely wrong. So, we took Charlie Munger’s advice:
“Invert, always invert.”
Instead, the Buycaster flips the question on its head: “what needs to happen in the business for me to – rationally – expect my required return?” This approach is far less arrogant and far less prone to dubious theoretical assumptions that don’t hold up in the real world. The Buycaster is rooted in reality – how pari-mutuel markets actually function, not how they’re supposed to function in theory.
"In theory there is no difference between theory and practice - in practice there is." - Yogi Berra
Rationality is the north star of the Buycaster. We break it down into Sanity and Safety. We want to make sane and safe investments, so we can generate high returns without losing a minute of good sleep. That’s why, while making the Buycaster even cleaner and leaner, we’ve also changed the name of our “Buycaster Rating” to the “Rationality Rating”. This quantifies the likelihood of a stock delivering our required return. The dashboard then depicts – intuitively and step by step – how and why a stock got its Rationality Rating.

If you like the story of a company (the product, service etc.), use the Buycaster as your financial analyst, your nerdy number-cruncher. Often, a great company does not make a great investment. Weed those out. And, if you get a hot tip from someone or find an equity research report from some brokerage house, use the Buycaster as a second (rational and, might I add, significantly less dull) opinion.

Apple's Rationality Rating

Take Apple, for example. Here’s a step-by-step analysis that you see in the cleaner, leaner, more rational Buycaster:

At the end of the day, what we’ve tried to manifest is this notion right here:
“To us investing is the equivalent of going out and betting against the pari-mutuel system. We look for a horse with one chance in two of winning and which pays you three to one. You’re looking for a mispriced gamble. That’s what investing is. And you have to know enough to know whether the gamble is mispriced. That’s value investing.”
In our universe of nearly 4,000 stocks, all we’re trying to find is “the horse with a 1-in-2 chance of winning that pays us 3-to-1”. That’s the best anyone can do in this game. And the Buycaster goes a long way towards making sure we “know enough” to find that mispriced bet.

Many Happy Returns.

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