Studying about valuations
Lately, I have been watching a whole loads more investing videos and I came across a talk by the ‘Dean of Valuation’, Aswath Damodaran, on how to value companies. Valuation has been a thing that I’ve been interested for a while, but not the actual ‘accounting theory’ itself. Funny enough, he was recounting his story in this talk about how ‘boring’ it is to teach accounting and how he covertly ended up transforming that class into a valuation class instead.
The thing about understanding financial statements from a company’s annual or quarterly report just requires knowledge of simple arithmetic. The hard stuffs is to understand accounting terminology principles, and conventions. But these conventions that accountants use can throw you off because it does necessarily make intuitive sense.
For example, the first thing that they tell you about the balance sheet, is this formula:
Assets = Liabilities + Equity
The first time I saw this formula, I thought it was just plain idiotic - how
liabilities be an
asset? For most of us, the equation makes the
most sense when expressed in the following way instead:
Equity = Assets - Liabilities
This actually tells you what is actually yours, which seemed like a more practical thing that people wants to find out. Maybe it’s just because of some age old convention, like for example the conventional diagramming for circuit diagrams that people use in books - real electric current actually flows in the reverse direction than what is taught in the books! But due the first people messing it up, we ended up deciding to keep with the convention for consistency(?), and everybody else having to learn this reverse-brainfuck in engineering school. (I’m just imagining that someone screwed it up in accounting school right now. ;)
Learning valuations is important if you are an investor
Adulting is hard, why go through the trouble of learning things like how to
budget your expenses, or even worse, read financial statements? Just go buy your
Apple, Tesla, or dollar-cost-average the SPX index instead?
(The last suggestion does make a relatively safe investment over a long
duration, statistically speaking).
They are big, world-renowned companies, surely they will be sound? And stocks only go up, em’right?
But if one were to go through the numbers of many of those well-known, say, tech companies, you’ll find that for the price they valued at, it will take their earnings 100 years or longer in order to make a positive return on your investment!
No doubt, some of these companies may grow at an incredible clip that revenues will catch up to their valuations faster, but I do want to be aware of this information before making an investment decision. Without understanding valuation, I could have quite likely paid for much more than my patience allows for to wait till if/when the company actually makes the expected payout.
The other crucial reason to learn valuation, is to understand if the earnings of the company is sound, or matches the narrative that it is selling to the investor. Sometimes, the numbers might not match the company’s forecasts, or in the worst case, be a total fiction.
Frauds can happen, and they happen often enough in companies to be alert. While I wouldn’t compare myself to an expert accountant in the field, but at least I’ll have a reasonable understanding to identify some of the red flags or to make a judgement as to whether the risk justifies the returns.
I am cognizant that no valuation or analysis of a company will make it impervious to failure, but at least I would have made my best judgments based on the known information I worked out.
That is important, personally.
I had been re-listening to a book titled “Thinking in Bets” by Annie Duke, in which it explains that it is very possible for one to make a good decision that ends with a bad outcome. That is is probability in play, and in life. But if I have taken into consideration of all the information, did my due diligence and yet my investment turns sour, I would have a good conscience that I did all I can to feel bad. Conversely, if the analysis pans out, it would be treated as just another step towards my personal goal of attaining financial freedom.
It is one thing to figure out your own plan to be free, it is quite another to help someone else accomplish it. We all have to take our own risks in this journey and it ain’t the easiest for me to suggest to womanfriend on what to do with her money.
For now, I’m takings a more cautious and slower approach, as it is not about me suggesting what she should do, but rather that it is for her to understand and be comfortable with her own choices.
The basic awareness that stocks can go up, and down, would be the first lesson to instill. The second is to ‘never lose money’. If we can avoid ruinous outcomes, the worst case is only a subpar investment outcome. Better that, than a wilful ignorance to a subpar outcome via inflation anyway.
Sure, maybe what I’m teaching her won’t make her a millionaire, but the hope is that it will… and if it happens, I’m gonna share with all of you, my loyal readers, my investment secrets, all for the very affordable price of $9999.99! ;)