Common sense is the heart of investing and business management. Yet the paradox of common sense is that it is so uncommon. For example, people often refer to a stock or the market level as either “overvalued” or “undervalued.” That is an empty statement. A share of stock or the aggregate of all shares in a market index have an intrinsic value. It is the sum of all future eash flows the share or the index will generate in the future, discounted to present value.
Estimating that amount of cash flow and its present value are difficult. But that delines value, and it is the same without regard to what people hope or guess it is. The result of the hoping and guessing game—sometimes the product of analysis, often not—is the share price or market level. Thus, it is more accurate to refer to a stock or a market index as over priced or underpriced than as overvalued or undervalued.
The insight that prices vary’ differently from underlying values is common sense, hut it defies prevalent sense. Think about the ticker symbol for the popular Nasdaq 100: QQQ. The marketing geniuses at the National Association of Securities Dealers may have chosen three Qs because Q is a cool and brandable letter (think Q-Tips). In choosing from the letters N, A, S, D, and Q, however, they selected the one (three times) that stands for Quotation and unwittingly reflect a quote-driven culture by this quintessential^ New Eeonomy index created in mid-1999.
Quotes of prices command constant attention in the mad, modern market where buyers and sellers of stocks have no idea of the businesses behind the paper they sw’ap but precisely what the price is. Quote obsession trades analysis for attitude, minds for myopic momentum, intelligenee for instinct. Quotations are the quotidian diet of the day trader, forging a casino culture where quickness of action fed by irrational impulses displaces both quality and quantity of thought. QQQ is an apt symbol the most volatile index in stock market history.
In the Q culture, common sense is common nonsense, putting price on a pedestal and all but ignoring business value. The Q trader sees price as everything. The smart investor knows what value is. She focuses on value first, and then compares value to price to see if an investment holds the promise of a good return. That kind of focus requires the investor to operate as a business analyst, not as a market analyst or securities analyst and certainly not as a Q trader.
This book develops a mind-set for business analysis as the antidote to the Q culture. It discusses the tools of stock picking and highlights critical areas of thinking about markets and prices, and businesses and managers. It builds a latticework of common sense to fill the vast value void in today’s markets.
The book first shows you why it is a mistake to operate as a market analyst or to look to the market to reveal value when all it can do is reveal prices. It then presents the tools to think about performance and value but also cautions about how financial information can be distorted in ways that can mislead you. Accordingly, it argues that an essential element of intelligent investing is a com-monsense ability to assess the trustworthiness of corporate managers, principally the chief executive officer and board of directors.
The business analysis approach to investing shatters many myths of investment lore prevalent in the Q culture though not unique to it throughout history. For example, it rejects a distinction as pervasive as it is mistaken between growth investing and value investing (or between growth stocks and value stocks).
To be sure, some companies show greater promise of earnings growth than others, but all rates of growth are a component of value so this distinction, crys-talized in the early 1970s and a growing fixation ever since, is of no analytical value.