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In a perfect world, the share prices of all quoted companies will accurately reflect their true valuation. They will take into account such things as each company's future growth rate, their debt, their return on equity, their dividend payout ratio and their cash in the bank. And that's not all.
Obviously Freeserve is a special case -- an incredibly fast-growing company, operating in a new medium (the Internet) and with a somewhat unpredictable future earnings stream. Those facts make Freeserve incredibly difficult to value.
At any given time, market demand will determine the market value of a company. The same goes for houses. Why is a house in Hampstead, London, worth £1m today? Because that's what the market says it's worth. What's its true worth? You could work out how much it would cost to build a new house on that land from scratch, but you'd still have the problem of trying to place a semi-accurate value on the land. The bottom line is that it's impossible to place a true value on a property.
Having said the market is inefficient at any given time, the companies within the Qualiport's circle of knowledge seem rather efficiently priced just at the minute. We've no investment ideas at today's prices. There's companies we'd love to buy, but they are way too expensive. We need a margin of safety. For example, I fancy a bit of Vodafone AirTouch (LSE: VOD), but not at a forecast forward price to earnings ratio (P/E) of 64.
As usual, there's some great threads going on the Qualiport discussion board. Buffett fan MattRB posted this excellent message titled "Warren Buffett and Value Investing". Rakugoka came up with "Buffett Speaks to the Qualiport", rightly urging us to continue to concentrate on the long-term. Dive in with your thoughts and opinions. The great thing about investing strategies is that there's no right or wrong answer. Money ultimately talks.
I talked about special situation investing on Wednesday. Time and space (I got carried away with the efficient market stuff) have scuppered me. I'll pick up on the theme again the week after next. Maynard is back all of next week. Have a great 2-day (boo) weekend.
CM: This is a very unusual period.
CM: Zero unemployment, rampant speculation... a very amazing time.
WB: We don't know how it will end.
For a full report, check out this article at Fool.com.
Efficient Market
There's a couple of obvious problems with this theory, the biggest being that there's no perfect way to value a company. How much is Freeserve (LSE: FRE) worth? Well the stock market currently says it's worth over £4 billion. Does that reflect its true value? Or, given its potential, is it really worth £10 billion? I'd defy anyone to come up with a true and accurate valuation.
Predictable Earnings
However, what if you were looking at a fast growing company with predictable earnings? Suddenly, valuing that company is not as difficult. I think Dell Computer Corporation (Nasdaq: DELL) fits that bill. It has consistently grown its sales, and its earnings have grown by an astounding compounded rate of 60% over the past three years. It does have challenges, as do all companies, not the least being that the long-term future of the personal computer is far from assured, although I for one believe it will be around in a similar format to that which we see today for at least another 10 years.
It is only those companies which have predictable earnings streams that you can hope to semi-accurately value. Any other form of investing, where you can't confidently place some sort of semi-accurate value on a company, must by definition be speculation. The Qualiport, like Warren Buffett, is not into speculation. A shareholder in Freeserve is speculating.
Market Demand
The prices of houses fluctuate, usually depending on macroeconomic forces such as the state of the economy, the indefinable but important feel-good factor, inflation and interest rates. Why are house prices rising above inflation at the moment? Demand. Pure and simple. Fear and greed also play a factor, as they constantly do in the stock market. Fear that you're missing out on the gains that everyone else seems to be making, and greed because you want to make some easy money, like everyone else. Or so it seems.
How does this relate to the stock market? On any given day, the value of a company will be determined by the laws of supply and demand. Freeserve is worth £4 billion today because that's what people are prepared to pay for it. If people were prepared to pay more, its value would be higher. The opposite is also true. So, to some extent, the market is efficient, because it efficiently balances supply and demand.
But, if the market is efficient, how is it that anyone makes any money? A truly efficient market will result in all investors making average returns of about the risk-free rate, currently 6%. Yet, over the long-term, market returns have historically been much higher than the risk-free rate, because the market is not efficient. At any given time, some companies will be mis-priced by the market.
Where Are The Opportunities?
What we need is a good old market correction. That would throw up a few good buying opportunities. However, we're not desperate to buy, and we're not sitting on a massive cash cache. And besides, although we don't make market predictions, I just get the feeling the overall market is going nowhere, for the time being. But, whilst fear and greed still exist as human emotions, we won't have to wait too long for that situation to be reversed.
Discussion Board
Finally...
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