Ripoff Or Bargain?

G’day Foolish readers,

If you want to be a successful sharemarket investor, you must be able to assess the value of a business. Of course, it doesn’t need to be accurate to the cent — in fact there’s really no ‘right’ answer — but you need to have a reasonably good idea.

If you can’t do that, or don’t have access to someone who can, you shouldn’t go anywhere near the market. After all, how can you possibly know if the market price is ‘cheap’ or ‘expensive’ without some notion of ‘real’ — or what some people call ‘intrinsic’ — value?

And, just like that, I’ve probably lost most readers already…

Too Hard

Valuation can be hard, really hard. You need a good appreciation of business, accounting and mathematics, and even then there is a lot of subjective reasoning involved. And, as such, valuation can be something of a dark art.

Two people, using the same approach, and similar assumptions, can come up with wildly different values. Little wonder there is such a wide range of broker forecasts out there — even for relatively straightforward companies.

At any rate, even if you do arrive at a sensible valuation, and one that will prove accurate in the fullness of time, it won’t do you much good unless you have the proper temperament. The fact is that it often takes the market a long time to appreciate the value of a company. In the meantime, your faith can be sorely tested by (sometimes brutal) losses.

So given the expertise needed, and the work required, why bother if the results are often so unreliable, or take so long to yield results?

Generally right, specifically wrong

Investors should bother because it is the only rational way to approach the market. Without a sense of value, you are merely following the herd — and we all know how that tends to work out!

Besides, you don’t need to be highly accurate. Investing is about being generally right as opposed to specifically wrong.

For example, the latest recommendation for Motley Fool Dividend Investor, released yesterday, is worth at least 40% more than what the market is currently valuing it, according to my calculations.

Now my fair value estimate is almost certainly wrong, but even if it’s broadly right, it’s easy to make the case for value.

Next, in all my assumptions I’ve used rather conservative estimates. Perhaps, overly conservative. But that’s ok — i’m happy to build in a buffer of sorts to account for the vagaries of forecasting. If the company misses the mark on a few measures, it won’t bust the investment case.

Also, I tend to avoid companies that operate in notoriously difficult industries. I simply can’t hope to guess what commodity prices will be in a few years — so I just stay away from most mining companies. But the latest Dividend Investor recommendation has attractive and enduring qualities that should allow it to continue generating outsized returns for many years to come.

Finally, i’m not wedded to any one valuation approach, or set of assumptions. At Motley Fool Dividend Investor we test a variety of assumptions and use a range of techniques. All have their flaws, but in aggregate, if most point to value, it goes a long way to support the case for value.

Foolish Takeaway

Most of our members are too busy to analyse companies full time, which is why they outsource the work to us.

But in helping members identify value, we don’t delude them with false specificity. We stay within our circle of competence, adopt a conservative approach with estimates and valuations and avoid companies with unacceptable risks.

It’s been a winning formula to date — with our scorecard (so far) thumping the market.

And with our latest recommendation offering a 5.2% fully franked yield, trading on only 10.6 times forecast earnings, and is well below our assessment of fair value, we expect that to continue!

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