Improving On Buffett And Desert Cat

[CrushinFelt]

David,

I agree fully with the fundamental idea that you are using in this thread, but I don't believe it would have as much of an impact as you appear to think.

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In other words, no matter how good you are, if your opinion differs markedly from the present price, the true valuation is almost certainly somewhere between those two prices. And probably closer to the market price.


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Everything about this was fine until the last sentence. If you picked a random handful of FA investors, you MIGHT be (and probably are) correct (I doubt you have data for this but it is a reasonable assumption). However, if we are dealing with the upper-eschelon of the FA investors, that last sentence is probably much less likely to be applicable.

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If, on the other hand your evaluation of a stock's worth is significantly different from your guess as to what the market price is, you have a play if you are about right about the market price. My gut feeling is that the best situation occurs when the actual price is shaded slightly toward you own valuation. In other words if you think a stock is worth 20 and you think the public will price it at 29, I would feel best about shorting it if it is about 27. Its an indication that some rich, smart people might be agreeing with me.


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I'm not sure how you can say that last sentence with any sort of real confidence. If the actual market price is shaded in the FA's direction, it is definitely possible that there are other FA investors who have noted the discrepancy and acted accordingly thus driving down the price. However, I don't think one can say with any real confidence that that particular explanation is more likely than the FA's "market price estimate" being wrong.

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But it is not moronic to say that the market is one of the best experts in telling you what a stock should BE. There are a few people who are even a little better than that. But if they are disagreeing with Mr. Market they should be very aware that the disagreement could signify that they have made at least a partial mistake.

BUT, their discomfort and trepidation should reduce if they can PINPOINT the reason why Mr. Market is disagreeing and refute his reason. When that happens they don't need to give themselves as large a margin of error.


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This is really the key to the whole thread and probably should have been placed in the original post. The only real question is to what extent this would actually help. I don't know the answer to that question because I don't know how many "plays" are turned away because of a narrow margin.

I also believe that guessing the market price after having done one's own analysis is probably much harder to do than David seems to think and probably has a very large variance. I would think a byproduct of this is someone's "market estimation skills" being worse than their FA skills could cause them to miss some good opportunities.

Finally, I think if any FA wasn't practicing this in at least some form, then I'd have to wonder how smart they really are. I would be willing to bet that most successful FAs practice this in at least some form and are not blindly throwing their money into the pot without at least wondering why such a large +EV opportunity exists when so many other people are analyzing most of the same information.

One note:

Stephen,

I think you are reading a little too much into David's words. He is very direct and likes to make sure there aren't gray areas when it comes to a parameter of the argument. You say "ad naueum"; I say thorough. And this isn't "David vs. Everyone" it is merely David's idea being put out in the open for critique.

[CrushinFelt]

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Edit: And let me make it clear that I don't ignore the market price. I have to understand why something is so cheap and why I disagree with the market, just to be sure I've allowed for all known risks. If something is just mysteriously cheap, that's a red flag that I don't understand it properly. But I don't adjust my value estimates for it.

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This is not really any different than what David is trying to say so long as you are factoring it in somewhere. Out of curiosity, what do you do when you seen a large discrepancy between your estimate and the market price? I'm sure you recheck your assumptions to make sure they still hold true. But if you don't adjust your estimates or at least dilute the amount of capital that you should optimally throw at such an opportunity, then it is likely that you are investing sub-optimally.

[PrayingMantis]

David,

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But it is not moronic to say that the market is one of the best experts in telling you what a stock should BE.

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Can you please elaborate on this statement of yours? In what sense does a current stock price tell you what the stock price "should be"? And what exactly do you mean here by "should be"? Obviously if the price is $4 today, then it is more probable that tomorrow (without any other knowledge) it will be somewhere in the range between $3.5 and $4 than in the range between $3 and $3.5, for instance, but this is a rather trivial point I think.

[Phone Booth]

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David,

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But it is not moronic to say that the market is one of the best experts in telling you what a stock should BE.

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Can you please elaborate on this statement of yours? In what sense does a current stock price tell you what the stock price "should be"? And what exactly do you mean here by "should be"? Obviously if the price is $4 today, then it is more probable that tomorrow (without any other knowledge) it will be somewhere in the range between $3.5 and $4 than in the range between $3 and $3.5, for instance, but this is a rather trivial point I think.

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I agree. I'm not really sure what David is trying to say. We aren't graded by our ability to accurately estimate future prices, but by our ability to make decisions that are profitable. Factoring in *current* prices, as long as it's done by a constant factor, should never materially alter one's decision to buy or sell, unless bid-ask spreads are extremely high.

What he's saying essentially is that the market price is a pretty good unbiased estimator of future prices. I don't disagree, but there's no real significance in terms of beating the market, except when you're dealing with derivatives. You don't make money by agreeing with the market.

[stephenNUTS]

I respect that Crushin

I just guess his recipe for investing orientated threads/debates is not my cup of tea...and if other posters have no issue with that or want to continue to discuss them with DS,I will stay away and keep my mouth ZIPPED

GL
Stephen [img]/images/graemlins/cool.gif[/img]

[adios]

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...What he's saying essentially is that the market price is a pretty good unbiased estimator of future prices. ....

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No he's saying that the current market price is at least a decent indication of the current, true value. Perhaps I"m being a nit, perhaps you meant future earnings.

[adios]

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I respect that Crushin

I just guess his recipe for investing orientated threads/debates is not my cup of tea...and if other posters have no issue with that or want to continue to discuss them with DS,I will stay away and keep my mouth ZIPPED

GL
Stephen [img]/images/graemlins/cool.gif[/img]

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FWIW I think David is really saying that if you disagree with the current valuation by a wide margin, you should be highly suspicious of the valuation you've arrived at. It's much more likely the market is right.

[Jimbo]

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FWIW I think David is really saying that if you disagree with the current valuation by a wide margin, you should be highly suspicious of the valuation you've arrived at. It's much more likely the market is right.


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If he had said that in the first place there would only be three posts in this entire thread. [img]/images/graemlins/smile.gif[/img]

Jimbo

[Mark1808]

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David,

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But it is not moronic to say that the market is one of the best experts in telling you what a stock should BE.

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Can you please elaborate on this statement of yours? In what sense does a current stock price tell you what the stock price "should be"? And what exactly do you mean here by "should be"? Obviously if the price is $4 today, then it is more probable that tomorrow (without any other knowledge) it will be somewhere in the range between $3.5 and $4 than in the range between $3 and $3.5, for instance, but this is a rather trivial point I think.

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I agree. I'm not really sure what David is trying to say. We aren't graded by our ability to accurately estimate future prices, but by our ability to make decisions that are profitable. Factoring in *current* prices, as long as it's done by a constant factor, should never materially alter one's decision to buy or sell, unless bid-ask spreads are extremely high.

What he's saying essentially is that the market price is a pretty good unbiased estimator of future prices. I don't disagree, but there's no real significance in terms of beating the market, except when you're dealing with derivatives. You don't make money by agreeing with the market.

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If the market correctly prices securities their can be no abnormal profits from research. Only when incorrect pricing occurs are abnormal profits possible. If a mis pricing is suspected by an analyst he ought to do a double take because the market is fairly effecient in pricing securities and the error is more likely to belong to the analyst then if for instance he differed in his valuation assesment from someone less competent, me for instance.

[Phone Booth]

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...What he's saying essentially is that the market price is a pretty good unbiased estimator of future prices. ....

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No he's saying that the current market price is at least a decent indication of the current, true value. Perhaps I"m being a nit, perhaps you meant future earnings.

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No I meant future prices - value is dependent upon the discounting mechanism (and the holder, to a lesser extent), so there's no such thing as the single current true value, other than the current price. Also, David keeps proposing hypothetical tests (not just in this thread but in earlier ones) regarding how he thinks any single security's price in the future is likely to be closer to the current price than any one person's estimate of its value. This is likely to be true even if you're a much better estimator of a security's "true value" than the market, as long as the market premium or discount to the true value tends to persist over time.

What some arguing against David are missing, however, is the following. If Stock X is trading at $50 and you estimate its "value" to be $70. But say, your threshold for buying is such that you'd only buy X if it traded at $45. Then it's entirely disingenuous to say that you think X is worth $70, because by your own action, you'd rather have $50 than a share of X. Clearly it's not worth $70 to yourself.