valuation/concept: where to from here

back to basics

One useful, I think, way of looking at stocks is to weight two complementary factors: valuation and concept.


I understand valuation to be the question of what’s the appropriate price to pay for an ownership interest in a given company. This is a function of several factors: the prevailing level of interest rates, the price/availability of alternatives (including fixed income) and one’s confidence that the basis for current valuation–assets and earning power–are sufficient for the company’s stock to maintain (at least) the current price.

An aside: Cost basis can be another consideration, although I think it’s dangerous to give this too much weight. I can’t help thinking of a friend who inherited a large amount of GE stock. Her cost basis was $1 a share. We were talking about the stock in the early 1990s, a time when it was a bit over $35 (this is before the 2021 1-8 reverse split, so $35 then is the equivalent of $280 today). It was becoming clearer that there was much less actual substance to the company than a brilliant PR presence had made many on Wall Street believe. My friend couldn’t bring herself to sell because of the large capital gains tax she would have to pay. She watched it lose three-quarters of its value in the ensuing years instead.

I have a somewhat similar problem with MSFT. I bought a large–for me, anyway–position on the management change in 2014. The stock is up 10x since (a reason to think the Clippers aren’t NBA champs any time soon). I can feel the same tug as my friend’s not to sell. My solution is to put some of the stock into a Fidelity-run charitable trust.


This is the reasoning behind one’s conclusion that the stock will be a strong performer in the future. Paradoxically, valuation can be the primary concept. If, for example, a stock is trading at 50% of its book value and that book value is a solid indicator of the worth of the net assets the company owns, and there’s every reason to think that asset value won’t deteriorate, then sooner or later some other party is going to seize control and, at worst, liquidate. One caveat: in this scenario, change of control must be possible–meaning no zaibatsu companies in Japan, no companies where dual shares give the founder absolute control.

More typically, concept consists of spreadsheets indicating the company will have surprisingly strong earnings growth + an elevator speech-ish statement of what makes the company special. This may include what you think the stock market in general doesn’t understand. For example, “ASML is the sole source of advanced lithography equipment used in cutting-edge semiconductors. This will be a hot market for years, both because demand for semiconductors will remain strong and because users want to create duplicate capacity in case Taiwan-based TSMC, the world’s only fab at the cutting edge, becomes a political hot potato.”

Generally speaking, in down markets valuation is king; in up markets concept is.

More on Monday.

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