Pathways for valuing the company
Finding values in businesses have been the key job for investors in the stock market. There are various kinds of pathways from which one can find the underlying value of the business. Investors have to be very clear in what pathway to use to uncover the true value of the business. In this post, we will seek some wisdom to find the pathways for finding the value in the business.
There are three ways major pathways one can use to uncover the value of the business, they are
- Information edge.
- Analytical edge.
- Behavioral edge.
In the information edge pathway, Investors try to find the information that others don’t have. Investors try to exploit the time lag the information takes to spread to the masses.
Information edge was exploited by various investors such as Buffet in 1950’s, Joel Greenblatt in 1980-90’s and many others. But in today’s information era, it is very difficult to completely exploit and make use of these advantages because lots of information regarding the company is equally available to all the investors. But we cannot say that the information edge has completely become extinct but it has reduced drastically when compared to 15-20 years ago.
There are lots of smart investors working all day long to uncover the true value of the company. They use various kinds of powerful analytic tools for screening the stocks which satisfy their various criteria. Those investors read various industry research reports and try to project the future earnings growth of the company and take a sensible decision on their research work. We say that most of the investors in the world fall into this category.
The most important point investors have to understand when they use an analytical edge pathway is that they have to think differently. For example, there is no piece of information about TCS or HDFC that isn’t freely available. All the information about the company is already uncovered. But one who is smart enough to interrupt the information differently from the consensus will have the analytical edge.
Investors have to remember German physicist Erwin Schrodinger words while using analytical edge,
“The task is not to see what no one has seen, but to think what nobody has yet thought about that which everybody sees.”
Behavior and psychology of the investors determines the value of the business in the short run. If investors think that this company would grow very fast, they would send the share prices sky rocketed in the short term even before the business start delivering its results. This type of irrational behavior leads the investors to uncover wrong information. They get the fake sense that, if the share prices are rising then the company must be good. But sooner or later when the irrational behavior settles, investors would know the true value of the business.
Being rational while evaluating the business is one of the main parts of valuing the business. There are various biases in which investors gets trapped into. Behavioral biases say that the main enemy of the investors is himself. Investors who have strong enough to handle mental biases can value the business more effectively than the others.
The thumb rule in investing is that, successful investing comprises of 90% in handling our behavior, 9% in valuing the company and rest comprises of 1%.
Behavioral edge pathway is one of the least used pathways because it is emotionally tough to detach completely from various biases and value the business. This also means that one who can handle his behavior effectively can exploit the market and make a lot of money. For example, in the bear market, everyone would fear to buy stock and that’s when stocks will be available cheaper and one who can handle emotions well and buy in those times will benefit a lot.
Which pathway to choose?
It depends on an individual level. If you are in a position to get unknown information or special insights about the company before it comes to market, you can easily exploit the information pathway for valuing the business. if you are good in analyzing statistically and can get along with numbers you can chose analytical edge pathway for valuing the business and at last, if you have got monk like patience and if you can master your emotions, you can choose behavioral pathway for valuing the business. We believe that behavior arbitrage exists in large quantity in the present market and one has to stay rational to evaluate the business and exploit the opportunities.