The Importance of Being Your Own Architect in Investment Valuation
Value companies for "an audience of one"
In the world of investing, there's a fundamental principle that all serious investors should internalize: you must be the architect of your own investment theses and valuation work.
This approach isn't just a suggestion—it's a necessity if you want to achieve consistent, long-term success in the stock market.
„Conviction is a lot like love and trust, it can only be built over time.“
Inspiration from Aswath Damodaran: The Dean of Valuation
Recently, I was listening to a podcast episode featuring Aswath Damodaran, often referred to as the "Dean of Valuation," on The Investor’s Podcast Network.
Damodaran is a well-respected figure in the investing community, especially known for his expertise in company valuation. His insights during the podcast inspired me to share my take on this topic with you.
In the podcast, Damodaran discussed the concept of valuing companies "for an audience of one"—himself.
This idea is powerful because it underscores the importance of personal responsibility and independent thinking in investing. While it's valuable to learn from books, fellow investors, and experts and consider their insights, relying solely on someone else's valuation can be a perilous path!
Building Your Own Investment Framework
If you're serious about investing, developing your own investment framework is essential.
In a previous blog post (“Framework First! The Power of an Investment Framework & Why It’s Essential for Long-Term Success“), I emphasized the importance of having a clear, personalized, and well-structured investment strategy – an investment framework that guides you through the world of volatile markets.
A critical component of any robust investment framework is the ability to accurately value the businesses you're considering. It’s a fundamental pillar in my investment framework:
To be able to determine whether a stock is attractively valued requires being equipped with more than just one valuation method but rather having a diverse toolkit of valuation techniques.
Each investment case, each business is unique, and the appropriate valuation method depends on various factors, including:
Business Quality: How strong and sustainable is the business model?
Business Durability: What is the longevity and resilience of the business?
Business Growth: What is the expected growth trajectory, and how does it tie into the business's life cycle?
Business Model: How does the company generate revenue and profit?
Predictability: How consistent and predictable are the company's cash flows?
These factors should guide your choice of valuation method.
For example, a high-growth tech company might require a different approach compared to a stable (or even declining), more mature utility company.
Additionally, the time horizon of your forecast—whether it's three to five years, ten years, or even longer—will also influence your valuation technique of choice.
Understanding the Strengths and Weaknesses of Valuation Methods
No valuation method is perfect. Each has its strengths and weaknesses, and it's crucial to be aware of these nuances.
For instance, Discounted Cash Flow (DCF) analysis is a powerful tool for estimating the present value of future cash flows, but it can be highly sensitive to the assumptions you make about growth rates and discount rates.
Similarly, relative valuation methods, like the Price-to-Earnings (P/E) ratio, are simple and widely used, but they can be misleading if factors such as corporate debt, ROIC, and cyclicality are not taken into account – or even worse, if you rely on relative valuation and if the comparison companies are not truly comparable or if the market is mispricing the sector as a whole.
The key is not just to learn how to use these tools but to understand when and why to use them.
Moreover, I’d even argue combining multiple valuation approaches can provide a more comprehensive picture of a company's intrinsic value.
The Dangers of Outsourcing Your Investment Decisions
Relying on someone else's valuation work or stock recommendations is a recipe for disaster.
When you buy a stock simply because a famous investor, a finfluencer, or a major financial institution recommended it, you're outsourcing your decision-making process.
This lack of personal conviction can lead to panic selling when the stock price drops, especially if you don't fully understand the underlying business or the rationale behind the recommendation.
Damodaran's philosophy—valuing for an audience of one—reinforces this point. Your valuation should be the result of your own analysis, tailored to your own investment goals and risk tolerance.
Only then can you invest with confidence, even during periods of market volatility.
“When I value a company, I'm very open about the fact that I value companies for an audience of one. Me. My value drives my decision.
Shouldn't drive your decision. That's why when I value companies, I provide my story and the architecture, the valuation to you so that you can disagree with my story, value the company on your own and make your decisions. I think when you outsource investment decision making and say, I'm buying the stock because Goldman Sachs told me to buy the stock, or I'm buying the stock because Warren Buffett bought the stock, you're outsourcing your decision making.
And we've got to take ownership of our investment decisions because that's the healthiest way that I can think of investing.”
From We Study Billionaires - The Investor’s Podcast Network: TIP654: Investing Across the Life Cycle w/ Aswath Damodaran, 23. Aug 2024
Empowering Yourself with Knowledge
In my mentorship program, I provide clients with the tools they need to conduct their own valuations and business analysis. This approach not only helps them make informed investment decisions but also builds the confidence necessary to withstand market fluctuations.
Investing successfully over the long term requires more than just following trends or copying others. It demands a deep understanding of the companies you're investing in and a personalized approach to valuation. By developing this expertise, you can turn valuation into a superpower that sets you apart in the investing world.
I'd love to hear your thoughts on this topic. What is your favorite valuation tool, and how do you incorporate it into your investment strategy? Let me know in the comments below.
Take care, and happy investing!