One of our favorite investing books here at The Acquirer’s Multiple is The Little Book of Valuation, by Aswath Damodaran. There’s a great passage in the book in which he discusses the importance of being able to value stocks before buying them:

“Oscar Wilde defined a cynic as one who ‘knows the price of everything and the value of nothing.’ The same can be said of many investors who regard investing as a game and define winning as staying ahead of the pack.”

“A postulate of sound investing is that an investor does not pay more for an asset than it is worth. If you accept this proposition, it follows that you have to at least try to value whatever you are buying before buying it. I know there are those who argue that value is in the eyes of the beholder, and that any price can be justified if there are other investors who perceive an investment to be worth that amount. That is patently absurd.”

“Perceptions may be all that matter when the asset is a painting or a sculpture, but you buy financial assets for the cash flows that you expect to receive. The price of a stock cannot be justified by merely using the argument that there will be other investors around who will pay a higher price in the future. That is the equivalent of playing an expensive game of musical chairs, and the question becomes: Where will you be when the music stops?”

In the final chapter of the book Damodaran also provides his ten rules for analyzing investments and assessing their value:

Do not let experts and investment professionals intimidate you. All too often, they are using the same information that you are and their understanding of valuation is no deeper than yours. Do not be afraid to make mistakes. I hope that even if not all of your investments are winners, the process of analyzing investments and assessing value brings you as much joy as it has brought me.

10 Rules for the Road

1. Feel free to abandon models, but do not budge on first principles.

2. Pay heed to markets, but do not let them determine what you do.

3. Risk affects value.

4. Growth is not free and is not always good for value.

5. All good things, including growth, come to an end. Nothing is forever.

6. Watch out for truncation risk; many firms do not make it.

7. Look at the past, but think about the future.

8. Remember the law of large numbers. An average is better than a single number.

9. Accept uncertainty, face up to it and deal with it.

10. Convert stories to numbers.

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