Do Valuations Matter?

Buyandhold 2012
https://seekingalpha.com/instablog/1677741-buyandhold-2012/5117110-valuations-matter

Summary

Of course valuations matter.

No stock is worth buying when it is significantly overpriced.

I will use Microsoft as an example of why valuations matter.

There has been some debate on Seeking Alpha as to whether or not valuations matter.  Chuck Carnevale seems to think that they do matter.  Chowder does not seem to place much importance on valuations.
I firmly believe that valuations do matter and that no stock is worth buying when it is significantly overpriced.

I will use Microsoft as an example to demonstrate my point that valuations do matter.

The current price of Microsoft is 92.00.  

The price of Microsoft on December 1, 1999 was 58.38.  It took almost 17 years for the price of Microsoft to rise above its price on December 1, 1999.  On September 30, 2016, the price of Microsoft was 59.92.

The price of Microsoft on February 1, 2009 was 16.15.

An investor could have bought 2,000 shares of Microsoft on December 1, 1999 for $116,760.  Today his investment would be worth $184,000.

Or an investor could have bought 7,230 shares of Microsoft on February 1, 2009 for approximately $116,760.  Today his investment would be worth $665,160.

So an investment in Microsoft on February 1, 2009 was clearly better than an investment in Microsoft on December 1, 1999.

Valuations definitely do matter.  No stock is worth buying when it is significantly overpriced.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Additional disclosure: I am not an investment professional. I make no recommendations regarding any stock. Please do your own due diligence. Information deemed reliable but not guaranteed.

Does Price Matter In 50 Years?

5ofDiamonds'

https://seekingalpha.com/instablog/16206862-5ofdiamonds/5167110-price-matter-50-years

Summary

You have a choice to pick Stock A or B, today.

Lets say, A is at 52 week High, and B is at 52 week low.

Lets also say that you did your research, and you like A as a better "business" (not just based on metrics).

A actually trades at higher P/E and PEG than B.

But you believe in A.

Should you buy A?

Of course.

The Q is - should you buy A, NOW?

Now, we are shifting from what should I buy to when should I buy i.e. at what price.

If I am convinced that the company A will continue to grow in the next 50 years, should price matter?

If I buy it at $9 vs. $10 (~10% price difference), all it means is that I will have about 10% profit difference in future i.e. if this company is really really good. $10,000 invested today may grow to $10M or $9M in 50 years.

But, what if I pick company B instead because its trading "cheaper" today, than Company A?

$10K invested in company B today, might grow to $2M vs. $9M in company A, after 50 years.

So, does the price of the stock matter so much more than the company itself that you choose to invest in?

No.

Its just that in real life, its hard to differentiate A from B.

But always focus on "A". Not the price.

My 2c.

The Little Book That Builds Wealth

PAT DORSEY

Over long stretches of time, there are just two things that push a stock up or down: The  investment return,  driven by earnings growth and dividends, and the speculative return,  driven by changes in the price-earnings (P/E) ratio.

Think of the investment return as reflecting a company’s financial performance, and the speculative return as reflecting the exuberance or pessimism of other investors. A stock might go from $10 to $15 per share because earnings have increased from $1 per share to $1.50 per share, or because even though earnings stayed flat at $1 per share, the P/E ratio increased from 10 to 15. In the first case, the stock was driven completely by investment return; in the latter case, the shares climbed solely due to speculative return.

When you focus your investment search on companies with economic moats, you’re maximizing your potential investment return, because you’re looking for companies that are likely to create economic value and increase their earnings over long periods of time.

By paying close attention to valuation,you’re minimizing the risk of a negative speculative return—that is, the odds that a change in the mood of other investors will hurt your investment performance.

After all, no one knows what a stock’s speculative returns will be over the next five or 10 years, but we can make some pretty reasonable educated guesses about the investment return. Careful valuation will help insulate you against an adverse change in market emotion.

Let’s look at a real-world example.

As of mid-2007, Microsoft had increased earnings per share at an average rate of roughly 16 percent per year over the past decade. So, 16 percent was the company’s 10-year average investment return. But Microsoft’s shares have appreciated at an average annual rate of only about 7 percent over the same time period, which means its speculative return must have been negative, to drag down that juicy 16 percent investment return. In fact, that’s precisely what happened—10 years ago, Microsoft shares were valued at a P/E ratio of 50, and today the P/E ratio is just 20.

Contrast Microsoft with Adobe, which produces Photoshop, Acrobat, and a host of other image-processing software products. Over the past decade, Adobe’s earnings per share have increased at about 13 percent per year on average—that’s the investment return. But the shares have appreciated at almost twice that rate, about 24 percent per year, because over the past 10 years the stock’s P/E ratio changed from about 17 to about 45 today, which added a huge amount of speculative return.

As you can see, a change in the market’s mood—the speculative return—caused a drastically different outcome for an investor who bought shares of two companies in the same industry that posted roughly the same growth rate over the past decade. The Microsoft investor has received returns roughly in line with the market, while the Adobe investor has made several times his or her initial investment. Now, the Adobe example is an extreme; buying a stock with the expectation that the market will deliver a massive speculative return is folly. But by purchasing shares at a P/E of 17 a decade ago (versus a P/E of 50 for Mister Softee), the buyer of Adobe minimized the risk of the negative speculative return that whacked the buyer of Microsoft shares over the past 10 years. The fact that the lucky Adobe buyer benefited from a huge increase in the P/E ratio is gravy.

This is why valuation is so important. By paying close attention to valuation, you’re maximizing the impact of something you can forecast (a company’s financial performance) on your future investment returns, and minimizing the impact of something you can’t forecast (the enthusiasm or pessimism of other investors). Besides, who doesn’t like getting a deal?

My conclusion (Huynh)

When you need to decide between X and Y
+ X is a great business, but X is more expensive.
+ Y is not a great business, but Y is cheap.
you can either
+ Buy X. Forget about Y. You always need to find great businesses first, before looking at the price or anything else.
+ Better to find another business that both great and cheap to buy.
A great business is important.
Valuations are also important.
Great businesses matter more than cheap price.