Low-Stress Equity Investing

The inconvenient truth about equity investing is that all styles of investing – no matter how value-oriented or Buffett-ian or long-term – involve some level of speculation. I like to minimize speculation, so I can sleep well at night.

Important Note: I have written 73 Equity Sanity editions so far. This one makes it 74. It’s been fun, and I hope you’ve gained something from this newsletter. But I have decided to end it at lucky number 75 (so that's 1 more issue). Going forward, please click on The Buylyst and hit “follow” for more equity investing insights like this.

I see 3 levels of speculation:

1. High: I will predict what the crowd will want to buy tomorrow or next week.
2. Medium: I will make an educated guess about the true “intrinsic value” of the company and bet that the “the market will finally come around to my valuation”.
3. Low: I will operate with the leap of faith that eventually the market will be rational and will not pay more than “rational price” for any stock.

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Personally, I believe that Level 3 is the way to go. It’s the least stressful way to invest.

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Level 1 is, maybe, just a shade less speculative than pure gambling. The idea that one can reliably predict future stock price movements based on recent price movements and rumors is an attractive proposition. But there is no evidence that it works over the long-term. I believe that this method usually bets on continued bouts of irrationality rather than rationality. To me, that’s playing with fire.

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Level 2 is sounds very intellectual and professional, but it requires very precisely wrong forecasts of specific cash flow items and discount rates (based on dubious academic theories) which seems speculative to me. There is a sense of arrogance that comes with the word forecasting that I can’t quite digest. It has that shady crystal ball feeling to it. Now, one can argue that forecasting is essentially just about painting a “reasonable scenario”. To that I say, “yes! But let’s do it right!”, which brings me to Level 3.

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Level 3 requires me to back-solve from a “rational price” back to “what needs to happen in the business” to get to that price. Again, the leap of faith here is that we’re betting on rationality rather than irrationality. This is a slightly unusual way to thinking, but it works. So, let me spell it out a bit:

1. Rational Price translates to “Desired Price”.
2. Now, we back solve from the Desired Price to “what needs to happen in the business”.
3. Along the way, we make reasonable assumptions – about market multiples, margins, and cost structures – to quantify that “what needs to happen…”
4. “What needs to happen” is essentially “revenue growth that we need to believe”.
5. The extent to which that “revenue growth we need to believe…” is, well, believable, can be partially quantified and automated, but has a big subjective element to it.

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I’ve built tools that exemplify No.3. Buffett likes to say that Munger taught to him to look for “great businesses at fair prices” rather than “questionable businesses at low prices”. Well, The Buycaster certainly takes care of the “fair price” part of that equation. The “great business” part of the equation is (and always will be) mostly subjective. That subjective part can be as open ended as you want. But we all have limited time. Fortunately, The Buycaster also puts some much needed structure around that theoretically endless subjective analysis. Fair Price and Great Business are joined at the hip.

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Regardless of whether you believe they’re great business or not, what do you need to believe about their businesses to – rationally – expect a decent return? Here are 3 examples from the Magnificent 7…the Magnificent "A"s...

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The Buycaster goes into much more detail about these (and 6,000 other) stocks at the click of a button, but right at the outset it seems to me that one of these is a highly believable story; the others ask me to assume a lot in the business to expect a decent return on the stock.

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Assuming that a business will significantly outperform its recent past means overpaying for its stock.

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Never overpay for a stock again.

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Many Happy Returns,

Saurav