Hi Markus,markus75 wrote: ↑Tue Sep 20, 2022 5:03 amI think you have an incorrect understanding of discount rates and expected returns. A higher discount rate does not mean higher expected returns. A higher discount rate compensates for lower earnings/cash flows in the future. You end up getting the same expected return as you would from a company with higher future earnings/cash flow and a lower discount rate.Nathan Drake wrote: ↑Mon Sep 19, 2022 10:18 pm
But the market is smart, a drop in earnings would also cause an even steeper rise in the discount rate. Meaning, these companies are much riskier than previously thought and therefore should be priced for an even higher premium.
If not, the stock would be flashing up on everyone's screen, from hobbyist stockpickers to quant funds. In fact, this often happens, but today the stock price corrects too quickly. Too fast for any passive value fund.
No, that's very unlikely.Nathan Drake wrote: ↑Mon Sep 19, 2022 10:18 pm So the only true way for Value to lose its premium is for there to be no reason that valuations should be lower, meaning the companies are not more risky. Thus the p/e expansion would cause huge short term returns for Value
Short version:
Value can loose its premium if there are more companies in the Value universe which stock price will fall or never recover. It's normal in the world of capitalism that there are companies that are no longer successful and never recover. If the market is smart enough you have more of this companies in the Value universe.
Long version:
Value can lose its premium if the market is smart enough to only keep companies in the Value universe that have shaky earnings, unpredictable cash flows, or are extremely cyclical. It is very difficult for investors to determine the right discount rate and earnings/cashflows for these risky companies. My experience is that the stock price of those companies are even not low enough. It's more worth shorting those cheap companies, instead of buying it. But I don't invest like this way. The last seven years I have valued hundreds of companies, most in the Value universe and my impression is that the market is very smart because there are only companies left, where it's difficult to find a proper discount rate and the likelihood that the discount rate will increase in the future is much higher or the earings/cashflows will descrease. And analysts are overly optimistic about the future most of the time. Which means the stock price gets lower even more. This means that companies that look cheap today are actually still far too expensive. However, this will only become apparent in the future.
I think in the past that wasn't the case and there were more undiscovered good companies in the Value universe that were mispriced. But today forget it.
I think you are a very intelligent person. You should learn how to value companies with the valuation spreadsheets from Prof. Damodaran. Not for stock picking, but simply to broaden the horizon.
Clearly you have a lot of experience and knowledge I don’t have, but I’m going to disagree with you on a couple of points. I think first and foremost, markets price risk. When perceived risk increases, P/E multiples contract and expected returns increase. I agree with you, that most SV stocks probably don’t do well. But that is the nature of the beast and expected. It’s the rationale for passive asset class investing. The returns of any asset class, in fact the returns of the stock market as a whole, are generally the result of just a few big winners. That is not a reason to avoid an asset class. Instead it’s the reason to broadly diversify within the asset class and invest passively. We cannot predict the few winners that will determine the positive returns of the asset class as a whole. Lastly, and this is at the limits of my knowledge, I believe profitability screens help avoid the value traps you describe.
Dave
Dave