No matter how much some investors might wish it was not so, the biggest driver of whether or not you make money as an investor is the price you pay for an asset, says value blogger Andrew Evans.
On The Value Perspective blog, we appreciate not everyone shares our conviction that the biggest driver of whether or not you make money as an investor is the price you pay for an asset – that is to say, its valuation. Nevertheless, the casual attitude towards valuation recently displayed by company analysts at one investment bank has been especially noteworthy.
The problem with price targets
The identity of the bank is unimportant – albeit Google-able – but, after bringing Snap to market for $3.4bn (£2.6bn) in February, it issued a research note predicting the social media business would in due course hit $28 a share. The next day, the bank admitted it had made a mistake – overstating Snap’s profits over five years by some $5bn – and, having revisited its figures, had recalculated the share-price target as … $28.
Yes, even though the investment bank had in fact expected Snap to make $5bn less in profits over a five-year period, it still ended up forecasting the company would reach precisely the same valuation of $28 a share. All that was needed for this minor miracle of maths to occur was a bit of tinkering with some of the underlying numbers.
Admittedly one of those underlying numbers was the discount rate – effectively the number on which the whole method of assessing a business’s future worth, known as ‘discounted cashflow analysis’, is based. And this in turn has – ironically enough – raised some doubts about the future worth of company research but still … at least the analysts’ initial price target of $28 a share had been spot-on all along…
Well, maybe. If we were feeling optimistic we might interpret this episode as the market finally working out the utter futility of trying to forecast the future. After all, the investment bank appears to be acknowledging here it makes no odds if its analysts’ predictions happen to change and thus forecasting the future is as irrelevant to it now as we have always asserted it has been.
The 'inconvenient truth' of investing
Tempting as that explanation might be, we have to admit it is probably not the most likely one – just as we accept this is probably not the beginning of the end for discounted cashflow analysis, so loved by analysts. As we have argued in blog posts such as Notes of caution, this methodology is not ideal because it does require an element of, yes, long-term forecasting and yet clearly what we might call its flexibility will be seen as a plus point by some.
Nearer the mark as an explanation would be the unfortunate idea that, for some market-watchers, it is not forecasting the future that is irrelevant but valuation. Apparently we have reached a world where there are certain companies about which analysts can write what they like and then retrofit any and every forecast permutation because the wider market simply does not care what valuation they are trading on.
Right up to the moment, that is, when they really do care because they learn that simple truth we mentioned at the start. The biggest driver of whether or not you make money as an investor is the price you pay for an asset – that is to say, its valuation.
Andrew Evans is an author on The Value Perspective, a blog about value investing. It is a long-term investing approach which focuses on exploiting swings in stock market sentiment, targeting companies which are valued at less than their true worth and waiting for a correction.
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