Gannon On Investing

This post was prompted by a comment made to yesterday’s post (“On Friday’s Price Drop") by Bill of Absolutely No DooDahs. Bill began by writing:

More evidence that "value investors" are broad market timers, not only for the market overall but for individual stocks. Of course, most "value investors" would vehemently deny "timing the market."

(Read Bill's comments in full)

I do vehemently deny it. That is not to say that I am oblivious to moves in the market. I watch market prices carefully. However, the process of watching market prices is separate from the process of analysis. This is what differentiates value investors from market timers. A market timer acts with an eye toward future market prices. I do not.

Some value investors do. In fact, there are many value investors who value companies, at least in part, based on what they believe an acquirer might pay for the business. Many value investors will even cite examples of recent acquisitions, going private transactions, etc., and will value other firms within that industry at similar multiples (e.g., enterprise value/EBITDA) to what these other businesses were acquired at. I do not do this, because I see no reason why the multiples placed on businesses within an industry should necessarily remain the same over time. Intrinsic value is the only constant. I can not tell you what P/E is right for any stock. There is no right P/E.

What does all this babbling about multiples have to do with the original accusation? It moves us towards an important point. Some value investors are interested in knowing the price a third party would pay for a business; I’m not. If I put faith in that value, why shouldn’t I put faith in the value the market assigns a business?

In December, I wrote this about intrinsic value:

The intrinsic value of a business can not be determined through clairvoyance or calculus, prescience or projections; for, even the best projections sit precariously atop a mountain of complex assumptions. Determining the intrinsic value of a business requires simple arithmetic, common sense, and a careful analysis of the past performance and current financial position of the firm. Most importantly, it requires the separation of those things which are both constant and consequential from those things which are either mutable or meaningless.

I added the italics to make an important point. I do not believe the value assigned to a company by an acquirer, or by the market, is constant. I do believe the intrinsic value of a business is constant. True, my estimate of the intrinsic value of a business does not remain constant.

That changing estimate could be caused by one of three things: a change in the underlying reality, a change in the data (i.e., the available facts), or a change in my interpretation of the data. By far, the most common reason for a change in how one values a company is a change in how one interprets the data. The fluctuations of the market have more to do with epistemology than with economics. Market timers and some other types of investors do concern themselves with human psychology. Some concern themselves with raw emotions. Others concern themselves with cognition. Some use very technical terms. Others use very simple terms. I don’t do any of that.

Of course, I do care where the market trades, because I care about the prices of the individual businesses. I like low prices. I do not like high prices. However, I would hardly call that market timing. At any given time, I take the action I believe will prove most profitable. But, in determining which course of action will be most profitable, I do not attempt to form any judgments about future market prices.

Recently, I argued Overstock.com was worth at least $1.5 billion. It is now trading for less than $500 million. It may fall to $300 million. I do not know – and I do not seek to know. Tomorrow, I will look at the cash I have available to invest, I will look at the price of Overstock.com, and I will look at my estimate of Overstock’s true value. That is all I will do. That is not market timing. That is bargain hunting.

I can not speak for all value investors when I say that investing is a two track process. But, I can say that for me, it is a two track process – and it has always been a two track process. Those two tracks are the offer price and the value estimate. They do not cross; they do not overlap. Each day, they chug along. One day, I see the difference between them looks awfully wide. On that day, I buy the stock.

I have to lay down the value estimate track all by myself. No one does that for me. However, I needn’t dirty my hands at all for the market price track to appear. Little market elves must come out each night or something, because there is always an offer on the table. I do not have to worry about what it was yesterday or what it will be tomorrow. As far as I am concerned, today’s price is the only price.

A market timer does not limit his analytical abilities in this way. A market timer tries to perceive other prices beyond today. We can disagree as to whether this is a waste of his efforts. We can disagree as to whether there are any real profits to be earned this way. However, I think we can both agree that the actions of the market timer and my actions, as laid out here, are two very different things. Of course, you may yet believe that I do not actually follow the approach to investing I have outlined above. You may be right. The things we do and the things we think we do are often worlds apart.

I wasn’t the only one pleased by Friday’s price drop. Earlier today, Rick of Value Discipline wrote: “Rejoice! Corrections Bring Opportunity”

Visit Absolutely No DooDahs (it’s a fun site written by a smart guy – of course, I’m still right on this one).