The average investor continues to lag the performance of all major asset classes year after year. What causes this? Unfortunately, investors tend to jump in and out of their investments at precisely the wrong times. They pile into funds that have been performing well and redeem at the first sign of underperformance. Buying high and selling low eventually leads to this behavior gap.
Relative valuations
If you own a restaurant on a beach and the weather forecast shows a hurricane approaching, are you going to rush to sell the restaurant before the hurricane hits? Are you going to lower the selling price because you know the hurricane is going to hit and you are going to lose a few days or possibly weeks of business? Of course not! So why would you do the same with stocks?
The intrinsic value of the restaurant is not going to be impacted by the coming hurricane. Yes, they will lose business, and will probably have to repair some damage. Of course, there is a possibility that it wipes out the whole beachside town and it takes years to rebuild. But most market exogenous events in the past ten or twenty years weren't of the magnitude to destroy everything (in aggregate) for years.
We have to understand that regardless of what the 'market' is looking at, or what the pundits say on TV, a business is simply worth the present value of all future cash flows.
Here's the illustrative model. Let's say the market has an EPS of $10/year, and the discount rate is 4%. In this table, I just took the earnings for the next 10 years and discounted it back to the present at 4%, and then added a residual value at year 10 based on a 25x P/E ratio (or 4% discount rate), and discounted that back to the present and added them together. Of course, this would give the market a present value of 250.
First Year Earnings $0.00 Instead of $10.00
The intrinsic value of the market would go down less than 4%. With zero earnings for 4 years, the intrinsic value would go down by about 15%.
Zero Earnings for First Four Years
So, with the market where it is right now, it is like the market is discounting no earnings for more than four years!
The above tables clearly show that there is a negative impact on intrinsic value by even temporary business interruptions. But the magnitude is not nearly as much as the market usually moves.
We all had the same thoughts every time something happens. We all see some permanent negative change that explains a lower stock market. For example, after 9/11, the thought was that the world would never be the same, and that increased security measures will permanently reduce global growth potential and profitability.
Again, the market makes the news, and the market creates the explanations, not the other way around. We all try to model the facts to explain what is going on in the market to maintain the two illusions that 1. the market is always right, and 2. that we know what's going on. We wrap the market volatility tightly into these rational-sounding wrappers, pleased at having figured it out, secure in the knowledge that we know what's going on.
Stay home
Much needed humor
Zero Earnings for First Four Years
The above tables clearly show that there is a negative impact on intrinsic value by even temporary business interruptions. But the magnitude is not nearly as much as the market usually moves.
We all had the same thoughts every time something happens. We all see some permanent negative change that explains a lower stock market. For example, after 9/11, the thought was that the world would never be the same, and that increased security measures will permanently reduce global growth potential and profitability.
Again, the market makes the news, and the market creates the explanations, not the other way around. We all try to model the facts to explain what is going on in the market to maintain the two illusions that 1. the market is always right, and 2. that we know what's going on. We wrap the market volatility tightly into these rational-sounding wrappers, pleased at having figured it out, secure in the knowledge that we know what's going on.
Stay home
Much needed humor
