Monday, November 05, 2007

Some Thoughts on Formulaic Investing

As some of you know, I am an occasional contributor to Shai Dardashti's "Reflections on Value Investing." I think you will be impressed with the quality of serious contributors to the investment thinking that characterizes this blog. I commend it to your attention.

In today's edition, I discuss formulaic investing based on an article written some time ago by my friend Geoff Gannon.

Formulaic investing provides an important discipline to the investing process. It attempts to disengage us from the emotions that are so frequently associated with future poor results. Though not a substitute for thinking about other parts of the mosaic that comprise every investment, formulaic approaches form a very important backdrop to valuing a business. Necessarily, they are backward looking...valuations that depend entirely on formulaic approaches are extrapolating the past into the hereafter, not a sensible approach to looking at a business. After all, a stock's value consists of some sort of discounted value of all future cash flows. The past is, well it's passed. In immutable businesses, of which there are none, the thinking could end there. Remember the Buffett aphorism "The investor of today does not profit from yesterday's growth." Another one comes to mind, " If past history was all there was to the game, the richest people would be librarians." But as a starting point to the question, "What is this business worth?" formulas represent a useful benchmark for the economic reality of a business. Where it goes from here, what competitive influences will do, how it finances itself, how long the competitive advantage period will last are all unaddressed questions that are the add-ons that are needed to fully understand a business.

I apologize for my long absence from the blogosphere. Work expands, time contracts. Market opportunities are expanding with the crescendo of fear. Within portfolios, I continue to uphold the cornerstone of a value investment style, lethargy bordering on sloth.I appreciate your patience!


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