OT: How accurate are morning star, CFRA, Value

I was trying to understand how people value fair price of stocks…and there are so many firms out there such as Morningstar, CFRA and Value line with highly variable fair value prices.

Wanted to ask the board members whether these are reliable…and if these models had proven themselves during the previous recessions etc.?

Thanks a lot,
Charlie

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Imo, the thing about valuations is that the big winners in the stock market are usually those that are hard if not possible to value , and those that are easy to value will either never move much or most are value traps…

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I don’t think they are very valuable in terms of getting a good idea of what a firm is actually worth.

But they give a lot of information and good context, pretty quickly digestible.
It is also a good source of getting a handle on what the typical opinion of the firm is.

What about prices?
They provide some more detailed information that, if used judiciously, can offers some indication of likely returns in the short to medium term.
Whether the prospective returns are likely to be better than average or worse than average at the moment.
But I find that information is in the dry figures, like sales growth rates or ROE, not so much in their own predictions of likely one year or 5 year returns.

As an example, Value Line has a prediction of the rate of 3-5 year annual total returns.
As a stock’s price falls, this predicted rate of return rises.
In theory, buying the firms with the high predicted returns would do better than buying the ones with the low predictions.
Which is true, but not true enough to be particularly useful.
The top 20% by projected annual return best the bottom 20% by only 2.0%/year in the last 20 years.
The top 40 by predicted return underperformed the bottom 40 by predicted return.
I wouldn’t build an investment strategy on that level of predictive power.

As an aside on that example:
Even though it’s not very predictive for a single stock, the aggregate range of 3-5 year predictions is a surprisingly good market indicator.
Every week they publish a figure for the Value Line Median Appreciation Potential.
See https://discussion.fool.com/there39s-a-decent-book-concerning-th…
Today’s figure is 17, so a solidly double digit return is predicted for the next 1-4 years.
The flaw of this is that they are at heart extrapolators, so like most analysts they tend to run a bit overoptimistic at the end of bull markets.

Jim

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20 years ago, the most accurate valuation for BRK (or Apple, Google, Microsoft, Facebook) would be “buy at any price”. That’s very difficult to consider at the time. It’s the qualitative that’s hard. How certain can anyone be about the growth rate?

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How certain can anyone be about the growth rate?

Pretty darned certain–with sufficiently modest expectations.

I count on trend value growth per share of inflation plus 7% to 8%. Think of it as ~8% in the current era, falling to ~7% a few years out.
Whenever we get results better than that I consider it a pleasant one-time bonus.

Historically a monkey with a dartboard could manage inflation + 6.5%.
My expectation of an edge of 0.5% to 1.5% is low enough that I believe my chances of being disappointed are pretty low.

FWIW,
the return since Feb 1996 has been inflation + 7.2%/year while P/B has fallen from 2.474 to 1.185.
the return since Aug 2014 has been inflation + 7.0%/year while P/B has fallen from 1.377 to 1.185.
So, my expected return has been about right in the past even while valuations were falling.
When they stop falling, it will make an easier bogey.

Jim

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I count on trend value growth per share of inflation plus 7% to 8%. Think of it as ~8% in the current era, falling to ~7% a few years out.
Whenever we get results better than that I consider it a pleasant one-time bonus.

I should have added it’s hard to estimate for those companies with 20% or more high growth rate, like brk 20 years ago. It’s also hard to estimate the bottom for those that are deteriorate. The estimates are relatively accurate for those with stable future, like brk now. About 9% growth rate of brk is mostly due to reinvestment of earnings, plus normal economic growth.

How certain can anyone be about the growth rate?

Very little. Often, individual companies defy overall economic trends and conditions. Whether iPhone invention or Azure pivot for Microsoft, or a pandemic induced vaccine discovery and thus ten of billions of profit for Moderna are predictable only through fundamental analysis.

People confuse overall economy with individual company performance, either because they are lazy or because they lack the willingness to understand the individual situation. For 20 years Amazon had a growth trajectory that has defied all economic cycle. Of course Amazon is unique, but that’s the point every company is unique in its own way. While Amazon is growing, it may be taking share from other retailers, or Apple from Nokia and Blackberry, etc. So economy sees economic cycles, individual names will behave differently.

Even in industries where you are a price taker, individual names often have a very different relative performance. Former Exxon CEO used to say Refineries is a 15% return business, but in no period you are going to see the returns within 10% ~ 20%. Think about that. The failure to recognize this often leads underestimate growth by value investors, and overvaluation by growth investors.

A company’s individual situation is more important than the economic cycle. Surprisingly it is not that hard either.

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For 20 years Amazon had a growth trajectory that has defied all economic cycle. Of course Amazon is unique, but that’s the point every company is unique in its own way.

There is an unstoppable momentum in business development. It was not difficult to see the trend for online shopping, because it’s so much more convenient for consumers. It’s much harder to predict that competitors like Walmart were so slow to catch up, therefore let Amazon have a free hand.

It’s much harder to predict that competitors like Walmart were so slow to catch up, therefore let Amazon have a free hand.

It is very evident in Amazon willing to forgo GAAP profits and invest heavily back into the business for long-term growth. When you are myopic or have a pre-conceived notion that this business is not profitable, never will be profitable you fail to see what others/ market see.

It is not like others didn’t react fast enough, but Amazon moved at lightning speed. Separately, for many companies, until a problem becomes existential, they don’t like cannibalizing their existing revenue streams. For ex: Dell/ HPE/ IBM all technology companies with strong existing presence in the data center, had products/ engineering talent in servers, storage and network, and engineers with software and services skill set. Yet, AWS, Azure (a company with no hardware experience) are #1, #2. How come? You think those companies didn’t see? or people within the company didn’t scream about the on coming revenue drain?

When Amazon was investing massively in AWS, many were naive to think there is no profit in hardware commodity business, celebrated IBM selling hardware businesses, came up with ridiculous valuations like Websphere is worth $100 B, etc. We are prisoners’ of our own bias and generally very good in explaining things in hindsight.

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Thanks a lot everyone. This was very helpful.
Charlie