The Essence of Valuation is Soundness Not Rate of Return: Part 1
Introduction on Stock Valuation
When it comes to writing about investing in common stocks, my favorite theme typically revolves around valuation. In fact, I once had a reader dub me “Mr. Valuation.” Which, I might add was very flattering to me. Moreover, in the context of discussing valuation, there are normally three concepts that are included. They are typically fair valuation, undervaluation or overvaluation.
Oh, but would it not be wonderful, if everything about valuation were that simple. In truth, the concept of valuation is much more complex than those three simple notions. Therefore, one of the primary objectives of this article is to broaden the reader’s perspectives and understandings of the incredibly important concept of valuation as it relates to investing in common stocks.
However, before I delve too deeply into this subject, I would like to offer these following positioning statements:
1. Just because a stock is technically trading at fair value, does not necessarily mean that it is a good or attractive investment.
2. Just because a stock is moderately overvalued, does not necessarily mean that it is a poor or unattractive investment.
In truth, there are circumstances where a moderately overvalued stock is a much better investment than a stock that is at fair value. The key, as will be discussed later, revolves around the potential growth of the respective company. At its core, investing at sound valuation empowers you to participate in the results that the business generates on your behalf as a stakeholder. When investing at sound valuation, if the business generates strong growth, the rate of return you can expect will also be strong -and vice versa.