Valuation is an art and, as such, it requires practice. Buffett has said that if he were teaching a class on investing he would spend all his time doing case studies where he valued companies.
It is amazing to me how many articles you find on the internet that recommend stocks that contain little or no analysis of the company’s valuation. A case in point is all the talk about GM’s IPO. I have yet to hear or read an analysis of the intrinsic value of GM so an investor can understand what he’s getting if he buys at the offering price. It’s as if this question doesn’t even matter to those buying the stock. (Hint: be very wary when someone is working overtime to sell you something.)
So how do you become better at valuation? First, you must master the basic tools of valuation by studying the great investing books and the letters, articles and speeches of great investors. That’s part of the reason that this blog exists and there are many others out there that are excellent.
Second, start building a file of case studies you come across that include good valuation work.
What’s a good valuation? It should be simple and obvious. The value should be compelling. You should feel a little twinge of greed that you missed that opportunity and have the thought that you’d buy the stock in a second if the opportunity repeated itself.
As you build this file and study it, it becomes, in the language of Munger, your own latticework of mental models that you can draw upon when you come across a possible investment.
For example, yesterday I posted Denali Investors analysis of Cardinal Health’s spinoff of CareFusion. If you study Denali’s thought process and how they valued the two companies, you can draw on that the next time you are analyzing a spinoff. Another rich source of valuations is the Value Investors Club. The ideas are rated, and if you focus on those that are highly rated, you will find some excellent work to emulate. With the benefit of hindsight, you can also see how those ideas worked out.
Of course you need to practice your own valuation work. Ideally, you can share your work with other experienced investors who can give you feedback. Make sure you have a clear, succinct valuation for every stock in your portfolio. You won’t always be right, but if an investment does not work out you want to be in position to learn from it by being able to go back and see where you went wrong.
Valuation is the essential skill to master if you want to be great investor. Without it, value investing makes no sense.