I blame the education system. Basic investing theory should be taught in high school.
We have to think of a share price as a number that is a sum of all future earnings, divided by powers of an interest rate according to how far in the future those earnings will be produced. That allows us to evaluate whether a share price is reasonable or unreasonable.
This concept is complex and most people can't understand it without formal education.
That education doesn't occur, so we have a huge mass of investors who have no idea what share prices mean. How can they possibly make good decisions?
Nobody knows how much money a company will make in its lifetime. And even for companies with rather stable revenues, dividends and number of shares are not fixed, so it seems rather useless making calculations using those ratios.
It's hard to predict future revenues of a startup.
But it's not that difficult to get pretty close - looking a few years into the future - for big, established companies like Coke and Pepsi and GM.
The Fed gives investors a 2 year outlook on interest rates. In the last 20 years, they have only ever lowered rates by surprise - and that pushes share prices up. You're highly unlikely to lose a lot of money getting surprised by interest rate moves.
Sure - anything can happen, but historically, over a 3-5 year period, Coke's revenue and profit hasn't been very volatile.
But the share price IS much more volatile. This is what you arbitrage on. The people who are investing in the moment, when you're investing for a longer horizon.
Basically, this strategy is that the short term is much harder to predict than the medium term. I think everyone is in agreement that the very long term (for stocks) is pretty hard to predict.
Charlie Munger said at the 1996 Berkshire Hathaway Annual Meeting: "Warren talks about these discounted cash flows. I've never seen him do one." "It's true," replied Buffett. "If (the value of a company) doesn't just scream out at you, it's too close."
Buffet says “The question is, how many birds are in the bush? What is the discount rate? How confident are you that you'll get [the bird]? Et cetera. That's what we do. If you need to use a computer or calculator to figure it out, you shouldn't [buy the investment]. Those types of [situations] fall into the "too-hard" bucket. It should be obvious. It should shout at you, without all the spreadsheets. We see something better.”
There is DCF and there is
DCF. The full-formed DCF spreadsheet is a creature of sell-side fiction. The more trivial analysis—how much cash will this business throw off over the next few years and what is that worth to me–is not formally DCF by the modern definition. But theoretically, it’s the same thing. Just dispensing with the garbage that is terminal value estimation.
https://old.reddit.com/r/brkb/comments/l9hpo5/buffett_explai...
I blame the education system. Basic investing theory should be taught in high school.
We have to think of a share price as a number that is a sum of all future earnings, divided by powers of an interest rate according to how far in the future those earnings will be produced. That allows us to evaluate whether a share price is reasonable or unreasonable.
This concept is complex and most people can't understand it without formal education.
That education doesn't occur, so we have a huge mass of investors who have no idea what share prices mean. How can they possibly make good decisions?