How can an overvalued stock be rated a 'buy'?

[luutzu]

No, it doesn't. It implies nothing of the sort. To say that "in the long run price will converge with value" means that a stock or any other security that is currently mispriced will at some point converge with value. It may do so only to become mispriced again because the market is dynamic, not static. It follows therefore that prices of securities are always diverging and converging from true value and when they do converge it does not mean their prices can never again diverge from true value in the future.....

What you just said there proves my point. That while at some point in the future, the market might get the price "right"; but when in the future; and what is the right price at that unknown future period?

A business is like a living organism right? It operates in a dynamic environment with declining or growing opportunities for its goods/services... So to say that in the future the price will be closer to intrinsic value - that in the long term the market is a weighing machine.. While true it's not really accurate when you apply it.

Example. Say I think company XYZ is worth at least $10 in the future. It now sells for $5.
When that future arrives and XYZ does hit $10... could I just conclude that that $10 is then the "true price"?
It depends right?

Dynamic environment; changing circumstances; new potential markets; less competitors etc. etc. All the new and then unforeseen factors may mean $10 then is way overpriced or way under the new "true value".

So just as we cannot say that old and established companies' share price are "true" on most days; we too cannot say that in the distant or medium future, the price will be true to its value. Therefore, we can only value a company based on current and existing information - That mean our estimate value must be referring to the value at this current point in time.

The idea of the long term the market reflects simply mean that others in the market do not agree with our assessment, but they are wrong and we are geniuses and given enough time - they too will see the light.

It does not mean that in the future, the business will grow to meet its true value.

 

[luutzu]

Art is not an investment. If you buy an artwork solely in the hope of being able to off-load it onto someone else at a higher price at a point in the future, you are speculating, i.e. you are hoping that someone will pay you a higher price than you paid. In the meantime, the artwork itself will not pay you anything. Contrast that with an asset that steadily and regularly throws off cash to the owner of the asset: I don't need anyone to buy that asset from me at a higher price than I paid for it in order to be enriched by those cash flows and in order for those cash flows to have a reasonably clear present value.

I made more of a social commentary than an argument

As a generalised statement, this is true. But if what you are saying is that an asset - say, a business that is presently losing money and will continue to lose money in the foreseeable future - is or can rationally be as valuable as a business that is presently profitable and will likely remain so, then that is less clear and may in fact be entirely speculative.

Could be reasoned speculation. Gotta live a little right?

 

[Rainman]

... Example. Say I think company XYZ is worth at least $10 in the future. It now sells for $5. When that future arrives and XYZ does hit $10... could I just conclude that that $10 is then the "true price"?
It depends right?... Dynamic environment; changing circumstances; new potential markets; less competitors etc. etc. All the new and then unforeseen factors may mean $10 then is way overpriced or way under the new "true value". So just as we cannot say that old and established companies' share price are "true" on most days; we too cannot say that in the distant or medium future, the price will be true to its value. Therefore, we can only value a company based on current and existing information - That mean our estimate value must be referring to the value at this current point in time... The idea of the long term the market reflects simply mean that others in the market do not agree with our assessment, but they are wrong and we are geniuses and given enough time - they too will see the light... It does not mean that in the future, the business will grow to meet its true value

I think the claim that you are trying to make is that everything is relative: i.e. that it is impossible to say at any given point in time that the price of a security accurately reflects the security's value because in the future circumstances may exist that render the convergence of the security's price with its value inaccurate.

Interestingly, you do not back up this claim with any real world examples. Why is that? Can't you find any?

I suspect that you can't because your claim is contradictory. You say or seem to say that if today I estimate the value of a particular security to be $10 per share and the security is then being offered in the market at $5 per share and if it takes 12 months for the price of the security to converge with its value of $10, the security may not really be worth $10 per share by that time because, in your words, "changing circumstances" have arisen over the course of that 12 months that may make the security overvalued (or undervalued as the case may be).

But how does that prove your point that one can never "say that in the distant or medium future the price will be true to its value"? In the example that you give, the "changing circumstances" have diminished the security's value, so of course when the price of the security finally reaches $10 per share it is overvalued. The value of the security has changed in the meantime and if I continued to hold it I would be a fool.

The only way that your point could be correct is if I remained ignorant of the diminution of value that these "changing circumstances" have had on the security's value and continued to hold onto it. But if I have remained ignorant of these "changing circumstances", the fault lies with me. How does my ignorance of factors affecting the value of my investment prove your point that one can never "say that in the distant or medium future the price will be true to its value"?

I understand that you are trying to argue that it is impossible to know at any given point in time whether a security is accurately priced in relation to its value, so why not just accept in the here and now that a security's value is its price and look no further.

But the made-up example that you give above does not prove your point and is implausible in any case. I think that if you backed up your claim with some real world examples it would demonstrate whether there is any empirical support for your claim and help you focus on whether your claim refers to something that occurs in the real world.

 

[luutzu]

I think the claim that you are trying to make is that everything is relative: i.e. that it is impossible to say at any given point in time that the price of a security accurately reflects the security's value because in the future circumstances may exist that render the convergence of the security's price with its value inaccurate.

Interestingly, you do not back up this claim with any real world examples. Why is that? Can't you find any?

I suspect that you can't because your claim is contradictory. You say or seem to say that if today I estimate the value of a particular security to be $10 per share and the security is then being offered in the market at $5 per share and if it takes 12 months for the price of the security to converge with its value of $10, the security may not really be worth $10 per share by that time because, in your words, "changing circumstances" have arisen over the course of that 12 months that may make the security overvalued (or undervalued as the case may be).

But how does that prove your point that one can never "say that in the distant or medium future the price will be true to its value"? In the example that you give, the "changing circumstances" have diminished the security's value, so of course when the price of the security finally reaches $10 per share it is overvalued. The value of the security has changed in the meantime and if I continued to hold it I would be a fool.

The only way that your point could be correct is if I remained ignorant of the diminution of value that these "changing circumstances" have had on the security's value and continued to hold onto it. But if I have remained ignorant of these "changing circumstances", the fault lies with me. How does my ignorance of factors affecting the value of my investment prove your point that one can never "say that in the distant or medium future the price will be true to its value"?

I understand that you are trying to argue that it is impossible to know at any given point in time whether a security is accurately priced in relation to its value, so why not just accept in the here and now that a security's value is its price and look no further.

But the made-up example that you give above does not prove your point and is implausible in any case. I think that if you backed up your claim with some real world examples it would demonstrate whether there is any empirical support for your claim and help you focus on whether your claim refers to something that occurs in the real world.

No. What i'm saying is that a company's value is always at the present - that we look at its historical performance, its current state, and we estimate what its likely future performance would be. All these are done at the present.

So at this present time, we come to our estimate of its value, or range of values.

Then looking at the market price, we'd buy if the market is undervalued relative to what we think the "true value" is most likely be.

Then the idea that in the long run etc.... that is simply the wait we would need to prepare for. That is, other people and the market are obviously not seeing the current value but in time they will.

In other words, I find a $10 million dollar painting at a garage sale. It is worth $10M but the unlucky seller thought it's a dirty old print and selling it for what the frame might be worth. Once I buy it, put it on eBay and others will bid up to $20M. That is, I didn't buy a print and wait for it to grow in value to $10M - it's already $10M when I bought it.


Real life example... Take Mermaid Marine (MRM)... Say I estimate its value to be at least $1 per share. It's selling for 25 cents a share. When I buy at current price of 25 cents I already am ahead - just the market does not agree with me.

When, if, the market come round to agreeing that there is value to MRM... nothing much has changed so it would still be $1 a share according to my estimate. But if the market has improved markedly and my estimate based on asset value are not so relevant and earnings and bright future is clearly happening - it just got more valuable.

So question is, how long am I willing to hold before the market may come to agree with me.

 

[Smurf1976]

Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.

The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.

 

[CanOz]

Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.

The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.

Excellent post smurf, what I've wanted to say but just couldn't find the time....

 

[luutzu]

Price can remain out of line with underlying value for quite some time and there's potential profit to be made following the trend. Hence it may well be sensible to buy an overvalued stock if (1) there is an expectation that the price will continue to rise and (2) the intention is to sell it once that trend nears its end.

The concept that what's happening right now (price) can remain out of step with what you'd otherwise expect (fundamentals) isn't unique to the stock market and occurs in all sorts of things. Just because it was hotter than average yesterday doesn't mean it won't be even hotter today and hotter again tomorrow.

If it could be done consistently, then for sure. But thing is I don't think it's possible to consistently predict the trend, nor is it possible to get out in time.

It's like shorting stocks... we can all have some idea that a stock is way out of whack and it's just a matter of time... but to put money on when that time is. That's just too much unnecessary risk.

It's just my opinion here but I think it's best to follow an approach that suits us, that we understand, follow it in all our investment decision.

To use one method with x variable at y value one day, then use same method with n variable at z value the next.. .or to switch between methods and approaches. That'd be like using a metric tape measure one day then next day use your thumb or hand span to measure.

I learn from my Dad to always use the same tape measure when measuring something important. Even if the tape measure is a bit off, it will be consistent and you won't stuff up (that much).

For any given stock, there are always reasons to buy or to sell or to ignore. To use a ruler that give in to one's mood is just too dangerous I think. Can't learn from mistakes or successes that way.

 

[Triathlete]

If it could be done consistently, then for sure. But thing is I don't think it's possible to consistently predict the trend, nor is it possible to get out in time.


It's like shorting stocks... we can all have some idea that a stock is way out of whack and it's just a matter of time... but to put money on when that time is. That's just too much unnecessary risk.


It's just my opinion here but I think it's best to follow an approach that suits us, that we understand, follow it in all our investment decision.
.

I have to disagree... at least in my own trading results it is possible to consistently predict the trend if you have the right knowledge and skill level. We do not have to be 100% correct at this make money.

It will also depends on what trend you are talking about short, medium or longer term as to how you will play the stock or indices.

Again having the right knowledge and skill level when shorting stocks or indices will lower that risk level.

I agree with your last statement follow an approach that suits you and increases your profits which is easily repeated, this is one of the surest way to increase your wealth.

 

[Rainman]

No. What i'm saying is that a company's value is always at the present - that we look at its historical performance, its current state, and we estimate what its likely future performance would be. All these are done at the present... So at this present time, we come to our estimate of its value, or range of values.

I agree.

Then looking at the market price, we'd buy if the market is undervalued relative to what we think the "true value" is most likely be.

Agree.

Then the idea that in the long run etc.... that is simply the wait we would need to prepare for. That is, other people and the market are obviously not seeing the current value but in time they will.

Agree.

In other words, I find a $10 million dollar painting at a garage sale. It is worth $10M but the unlucky seller thought it's a dirty old print and selling it for what the frame might be worth. Once I buy it, put it on eBay and others will bid up to $20M. That is, I didn't buy a print and wait for it to grow in value to $10M - it's already $10M when I bought it.

I don't think it is a very instructive example to use art which is non-income generating with fractional interests of a business, i.e. shares, which are income generating. Let's stick with real world examples using shares like your example below using MRM.

Real life example... Take Mermaid Marine (MRM)... Say I estimate its value to be at least $1 per share. It's selling for 25 cents a share. When I buy at current price of 25 cents I already am ahead - just the market does not agree with me...

No, that does not follow. Why are you "already ahead"? Are you saying that MRM's current quoted market price undervalues MRM's net present value?

If you are, then I am not sure that I agree with you. MRM services the off-shore oil and gas industry. This industry's capital expenditure is being cut back to the bone. Meanwhile, MRM has to service debt of $442,473,000 against equity of $779,117,000 (most of which consists of equipment and boats which would not fetch much in a fire sale in the current environment). MRM may be cheap. But if capital spending in this sector continues to be cut back as most people are predicting that it will, MRM carries risk of the worst kind - risk of a permanent loss of capital.

When, if, the market come round to agreeing that there is value to MRM... nothing much has changed so it would still be $1 a share according to my estimate. But if the market has improved markedly and my estimate based on asset value are not so relevant and earnings and bright future is clearly happening - it just got more valuable.

This is a non-sequitur. I don't understand how you arrive at this conclusion from the point you make immediately above it. If MRM's quoted market price rises to $1, I suspect a great deal will have changed - in particular, the price of oil will likely have started to rise, making a pick-up in capital spending in the oil and gas sector more likely.

So question is, how long am I willing to hold before the market may come to agree with me.

That is a purely personal decision. How is that relevant to your valuation of MRM or to anyone else's valuation?

 

[Rainman]

I have to disagree... at least in my own trading results it is possible to consistently predict the trend if you have the right knowledge and skill level...

"Consistently" is a very relative term. Technical traders that I know freely admit that they correctly predict trends (whether long term, short term or medium term) less 50% of the time. In many cases, it is only around a third of the time that their predictions are correct and these guys have been trading for years.

If a weather forecaster on the nightly news correctly predicted the weather less than 50% of the time, you'd switch channels and take you're umbrella every single day regardless of how clear the skies were outside.

 

[Triathlete]

"Consistently" is a very relative term. Technical traders that I know freely admit that they correctly predict trends (whether long term, short term or medium term) less 50% of the time. In many cases, it is only around a third of the time that their predictions are correct and these guys have been trading for years.

It does not matter how long you have been trading it depends on the level of knowledge and skill the trader has and how he/she approaches his/her trading.

If the technical traders that you know only get it right a third of the time then I would have to question whether it is of any use to them but I would be curious as to were they learnt there technical skills from..?

As I said before in my trading I have a far better success rate than that based on my own results...but everyone to there own.

 

[CanOz]

"Consistently" is a very relative term.

If a weather forecaster on the nightly news correctly predicted the weather less than 50% of the time, you'd switch channels and take you're umbrella every single day regardless of how clear the skies were outside.

You don't need to be right to be profitable Rainman, you only need your wins to be much greater than your losses. But you make a good point, trend following is not for everyone, as there are plenty that cannot handle the draw-downs of between 20-40% and a win rate in the low 40s to 50%.

Also, i think most technical traders or trend followers would disagree that they are trying to predict anything. Its more of an anticipation of probability in case the historical statistics hold true.

There are plenty of trend following traders that have been made famous and wealthy from their strategies that produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires.

Its seems our discussion has now expanded to a few threads, likely my fault there. Anyway, i've enjoyed the banter, thanks for your views and remaining civil through out.

Good luck for 2016.

CanOz

 

[Rainman]

It does not matter how long you have been trading...

Oh, it doesn't, does it? Are you aware of the saying that "there are old traders and there are bold traders but there are no old bold traders"? I know guys who have been "trading" for more than 25 years. These guys are almost pure "chartists" in that they pay very little attention to fundamentals. How long have you been "trading"?

... It depends on the level of knowledge and skill the trader has and how he/she approaches his/her trading... As I said before in my trading I have a far better success rate than that based on my own results...but everyone to there own.

It always makes me smile when I read technical traders talk about how their knowledge of technical analysis enables them to make successful directional calls.

Let me put this to you: if a doctor purported to base his diagnoses on a new method of diagnosis and that doctor's diagnoses of his patients' diseases were correct less than 50% of the time, would you ascribe any real predictive power to that doctor's method of diagnosis? Would you have much faith in that doctor's diagnosis of your own medical condition?

You wouldn't. By the same token, if, as is generally accepted, technical analysis correctly predicts stock prices accurately less than 50% of the time, does it make any sense to describe it as having any predictive power with respect to stock prices? Or does it make any sense to claim that technical analysis furnishes you with "knowledge" and "skill" to make successful directional calls with respect to stock prices?

If a body of knowledge only allows you to be successful less than 50% of the time, it is not "knowledge" and learning it does not result in "skill".

 

[Rainman]

You don't need to be right to be profitable Rainman, you only need your wins to be much greater than your losses. But you make a good point, trend following is not for everyone, as there are plenty that cannot handle the draw-downs of between 20-40% and a win rate in the low 40s to 50%.

I have never denied that technical traders make money. But see my earlier response to Triathlete.

Also, i think most technical traders or trend followers would disagree that they are trying to predict anything. Its more of an anticipation of probability in case the historical statistics hold true.

Isn't that just a long-winded way of saying that their trades are based on a hoped-for prediction? You are just playing the odds. That is gambling, pure and simple.

There are plenty of trend following traders that have been made famous and wealthy from their strategies that produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires.

Who are they? And where are they now?

 

[CanOz]

I have never denied that technical traders make money. But see my earlier response to Triathlete.



Isn't that just a long-winded way of saying that their trades are based on a hoped-for prediction? You are just playing the odds. That is gambling, pure and simple.



Who are they? And where are they now?

You must be just trolling, you cannot possibly be this naive, or one eyed about a subject, surely...

The most famous trend following traders were a group called The Turtles. Thier founders are still trading today as well as some of their original traders...

Here is a list of trend following funds Trend Following Wizards – Fund performance

I'm not a trend following trader by the way, i have nothing to gain from this debate, other than to illustrate that there is other forms of investment than 'value' investing Graham style.

 

[Rainman]

You must be just trolling, you cannot possibly be this naive, or one eyed about a subject, surely...... Here is a list of trend following funds Trend Following Wizards – Fund performance

You clearly have not checked the performance of the traders referred to in that link.

You have just provided me with a list of traders who, with the exception of one of them, all have negative returns. Are you drunk?

Not only are their returns negative for the year to date but I click on the historical performance for Abraham Trading Corporation for the last 5 years and I learn that it is 11.63% versus for the SP500 107.24%: http://abrahamtrading.com/performance.

And you look up to these guys?

More importantly, why would I invest with Abraham Trading for 5 years at 11.6% when I can buy an index fund and earn 107.24% over the same period? If it weren't for the fact that we have had no inflation for the last 5 years, you would have lost money by investing with Abraham Trading.

I can't believe that you have referred me to that link in support of a claim that there are other profitable methods of investing.

 

[Rainman]

Here is a list of trend following funds Trend Following Wizards – Fund performance

By the way, I'd be grateful if you could show me which of them has "produced consistent profits for many years, some even decades with equity curves that even dear old dad Warren would agree were smoother than Berkshires" (my underlining).

(I don't have a clue what you mean by "equity curves that even dear old dad Warren would agree were smoother" but perhaps when you find the trader that produces such "curves" and produces those "consistent profits" it will become clear to me).

Just to be clear: Buffett whom you seem to dismiss has been investing for, I think, between 40 and 50 years and has achieved an annualised return of 20% on tens of billions of dollars. Show me which of these "turtle traders" beats that.

 

[CanOz]

No, I don't 'look up' to them, I only posted the link as an example of a list of trend following funds.

I'll have a look tomorrow morning for a trend following fund with a better equity curve than Berkshire's....shouldn't be hard....

Here's some better performance https://www.trendfollowing.com/performance/

Buffet owned insurance companies, he put the funds to work, how can rainman do that? How are you going to go out and buy a railway, or a heinz???

 

[Rainman]

No, I don't 'look up' to them, I only posted the link as an example of a list of trend following funds.

I'll have a look tomorrow morning for a trend following fund with a better equity curve than Berkshire's....shouldn't be hard....

You do that.

But you didn't just post that link as "an example of a list of trend following funds". What would be the point of that if almost all of those funds lose money by trend following?

You posted it in support of your claim that there are other profitable ways to invest. I am still waiting to see these other "profitable ways to invest".

 

[CanOz]

You do that.

But you didn't just post that link as "an example of a list of trend following funds". What would be the point of that if almost all of those funds lose money by trend following?

You posted it in support of your claim that there are other profitable ways to invest. I am still waiting to see these other "profitable ways to invest".

There are real records in that last link I posted as well, equity curves.

You been living in a cave, reading buffet and Graham?