Why I’m Not Betting on Projections

Dear fellow investors,

Like most prior weeks, all of my efforts over the past seven days have gone towards reading The Intelligent Investor. While I don’t regret starting this project off by building “a sound intellectual framework for making decisions,”¹ I am itching to implement this newly minted mindset of mine in the next phase of my development, research & analysis. With only nine chapters left, I think I can realistically complete this book within the next two weeks. I knocked out chapters 8, 9, 10 and 11 since my last issue was published.

Chapters 9 and 10 I did not find pertinent to this project. Chapter 11, on the other hand, made it abundantly clear that Wall Street experts and individual investors are both “inept at predicting 1) the market as a whole, 2) industry sectors, and 3) specific stocks.”² When it comes to forecasting future results, my head immediately goes to intrinsic value, specifically intrinsic value that has been calculated using discounted cash flow analysis, as it takes into consideration a company’s projected cash flows. It wasn’t that long ago that I believed my success as an investor was heavily reliant upon my ability to calculate intrinsic value in this manner.

The idea is simple enough: determine how much more cash a business will produce tomorrow and purchase that growth for less today. Then I realized investing in a company based solely on its intrinsic value, derived through DCF analysis, is highly speculative work. If I wanted to be a speculator I would have continued day trading, but I didn’t and I don’t. Instead, I want to be an investor, and as Jason Zweig states in chapter 11, “intelligent investors excel by making decisions that are not dependent on the accuracy of anybody’s forecasts, including their own. (See Chapter 8)”

I obviously want to be an intelligent investor, but I rather like the idea of becoming a successful one who isn’t dependent upon the accuracy of their predictions. So, I took Jason’s advice and I went back and re-read chapter 8, which I found to be very applicable to this project in the first place.

Given the nature of Charted Holdings’ business model, I am looking to invest in both public equities and private enterprises. Regardless of the type of business (private or public) I am looking to invest in, I’d like to keep my approach to valuation consistent, and because I don’t want my success as an investor to be tied to the accuracy of my projections, I’ve decided to take my idea of value from some place other than a business’s potential future cash flows.

Assuming I am successful in building a permanent capital holding company and I do in fact acquire a private business, I would “determine the value of such a private-business interest by calculating [my] share of the net worth as shown on the most recent balance sheet.”³ Calculating value in this way, to me, feels more concrete compared to intrinsic value. That’s not to say I won’t calculate a business’s intrinsic value using DCF analysis because I will. Only I believe this type of financial modeling is best suited for determining whether or not a business has a future and what that future may look like, which, coincidentally, also makes that exercise quite useful in the management of an investment over time.

As far as my results are concerned, they would be “entirely dependent on the profits of the enterprise, or on a change in the underlying value of its assets.”⁴ However, as Graham points out, “critics of the value approach to stock investment argue that listed common stocks cannot properly be regarded or appraised in the same way as an interest in a similar private enterprise, because the presence of an organized security market ‘injects into equity ownership the new and extremely important attribute of liquidity.’”⁵

I, however, am no critic thanks to Mr. Market, my imaginary business partner. Mr. Market, like the stock market, tells me what he thinks my stake in a private business is worth. Every day he gives me the option to either sell my stake in the private company or add to it. For this reason I, like Graham, view liquidity as having the “benefit of the stock market’s daily and changing appraisal of [my] holdings”⁶ and the “ability to increase or decrease [my] investment at the market’s daily figure”⁷ if I choose to do so. For me liquidity is optionality, and the current quotation for a publicly traded business is entirely separate from my idea of value. I recognize this creates a discrepancy for me to potentially exploit. I have roughly two more weeks before my focus shifts from mindset to valuation. I cannot wait to begin this type of work.

Thanks for reading,

Eric Seel