Saturday, 2 February 2019

To avoid falling into a value trap, an investor must always keep asking, "why"?

Once you find an undervalued security trading at a substantial discount to your estimate of intrinsic value, your job is not over. 

"Why is the stock trading at this level and what catalysts will lead to its eventual reversal?" 

If you cannot answer this question, you should not be investing in the stock. 

This is second level thinking (Howard Marks) and it will keep you from falling into a value trap. 

An investor must always keep asking, "why"? 

  • Why is this occurring? 
  • What is the overarching reasoning or justification behind this particular scenario or occurrence? 

When you have those answers, you have to ascertain why the other side may (or may not) be wrong. 

  • Is there are mispricing here? 
  • There was a major disconnect between perception and reality - between the stock price and the intrinsic value of the business. Why? 

There can be from any number of reasons. Usually one or the other side is wrong from psychological or analytical misjudgements (sometimes both).

1 comment:

Anonymous said...

Most mispricings are due to psychological ... fear of loss / fear of missing out.

Mispricings due to analysis is very rare ... we're usually not smarter than the other investors.