Valuation Work Complements not Drives and Investment Thesis 13 Mar 2014

Valuation Work Complements not Drives and Investment Thesis

Investors too frequently decide to buy a stock based on fully disseminated, public information that the Street has already accounted for in the share price. Smart money looks forward and searches for information above and beyond what is already widely understood. The identify firms that are misunderstood, outperforming or at a point of inflection the Street is not yet aware of.

Deciding to buy a stock is an indication the buyer believes it is mispriced and cheap based on its level of risk. Simply, a stocks share price is based on the value of its future earnings and dividends. The decision to buy indicates the investor believes that the value of those is higher and that the consensus viewpoint has mispriced the asset. There are some additional components to factor in that can impact value, but investors need to remember this fundamental basis for the value of a stock.

This is not discount the value of performing strong analysis on a company. At times this can act as the differentiating factor supporting the investment thesis. This is particularly the case in small and mid-cap stocks, for large cap stocks there are lots of analysts doing lots of analysis that gets priced in pretty rapidly. However, for small and mid-cap stocks, a sum of the parts valuation analysis for example that demonstrates value not yet unlocked can lead to the conclusion a stock is undervalued. This can be a reason to own a stock but remember to identify the timeline and catalysts to unlock that value.

An old saying is “Invest in what you know.” The idea here is that if you work at a construction firm, you should invest in companies related to this. For example, you understand power tool manufactures, building supplies, construction equipment, home builders and may even have insight into retailers like Home Depot and Lowe’s.

By working in the industry, you may be aware of a new power tool release that is flying off the shelves, a company that is improving its image and slowly gaining market share or an unexpected price increase from a wallboard producer. This is information is often not widely understood and can lead to upside in the stocks based on higher future earnings. This is the basic idea behind invest in what you know.

The problem with only investing in what you know and understand is that it narrows your options. The individual at a construction firm will end up over exposed to the cyclical construction end markets. There are solutions to still gain knowledge and a diversified portfolio without having 5-6 different jobs. Market research firms like Research Optimus give investors an edge just like working in the industry can. It provides a further advantage though, it eliminates individual bias and provides broader coverage a market.

No matter what investment approach or style used, it is important to consider where your opinion differs from that of the Street and support this through analysis and industry knowledge. Market research can provide the edge needed and critical insights to a company and identify key information to help capture alpha and beat the market.

– Research Optimus

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