THE BOOK--Playing The Percentages In Baseball

For anyone not involved in corporate finance, this is exactly how an investment firm would go about valuing a company.  And they’d charge you a lot more for it!

I used to do something like this in valuing a stock, but with a twist.  Rather than me trying to figure out “fair value” for a stock, I presumed that the market has established the value, and I had to come up with “implied growth” of the company in order to match the value of the stock.  So, you’d get some optimistic growth projections in order for the market to be right.

You do it a few times and realize that you don’t need much of a difference in order for the market to be right.  A couple of percentage points here or there was all that was needed to make a bad investment into a good investment.

And really, who was I to know whether Cisco’s growth of 13% was reasonable, as opposed to say 9%.  That’s really what it came down to.  For any individual stock (and by “stock” we really mean a company of thousands of people, who deal with thousands of other companies each of which have hundreds or thousands of employees), your intuition was just as good.

See the baseball analogy here?  You can never know if one specific action was correct.  Only your overall strategy can be tested.  And, if you went with the 13% growth of Cisco as reasonable, but also presumed 13% growth for ALL stocks, well, then you were not being reasonable overall.

Exactly right, Tom.

When looking at the value of a business/ franchise/ whatever, you should ask yourself “What do I have to believe for this valuation to be right?”

McKinsey asked just this question of Amazon at the height of the dotcom boom. How can you justify the $XX billion valuation?

The answer was something along the lines of same size as market leadership (40% national share) in books, dvd, electrical equipment with 12% margins (ie, double wal*mart). In fact they created a range of possible scenarios and built a weighted average value ....

Perhaps somebody out there has the numbers for me.  This is what I’d like to know: take the 100 companies 10 years ago, that had the largest market valuation, while NOT turning a profit for 8 consecutive quarters.  (And repeat for 5 years ago.) Or, the 100 companies with the largest price to past year’s revenue ratio.

Basically, this is the 100 “unproven rookies that scouts drool over”. 

Take the SP500 or Wilshire 5000 or a combination of the two or whatever index would most closely be the market valuation population from which those 100 companies belong to.

How did they do 5 and 10 years later?

If the market was realllllly smart, that pool of 100 should at least exceed this index.  Is this what happened?

If the market was realllllly smart, that pool of 100 should at least exceed this index.  Is this what happened?

I don’t understand.  If the market were realllllly smart, wouldn’t they be valued appropriately and all stocks have the same return over time?

My own opinion is that the market was realllllly dumb in the late ‘90’s.  I can’t tell you how many times I wished I’d had the financial depth to short stocks.

Tom— I can probably try to track down the data—my firm has stuff like that.

By the way, the answer is almost certainly yes. It is **VERY** unlikely not to make a profit for 8 consecutive quarters ... it probably leaves only auto firms (not doing well) and airlines (all went to Ch. 11).

I was thinking startups.  I don’t know how fast Amazon, ebay, et al turned a profit, but I figured they were in the red for 2 years.  Maybe just a high price to sales ratio then.

Ebay turned a profit mostly from day 1.

Amazon (a lot more asset intestive) probably fits your criteria. I suspect most start ups staifying the criteria (8 consecutive quarters of losses) won’t be public ... perhaps during the dotcom boom but they’ll either have gone bust or have been taken over.

Another factor is that you’ll introduce signifcant (survivor) bias unless you do a random sample.

Anyhow, let me dig around and see if I can get any data

No survivor bias.  I am looking at stocks that existed 10 years ago that had a very high price to sales ratio, regardless if they are bankrupt today or not.

The question is: “If I invested in the highest risk stocks 10 years ago, how would I look today?”