Don't Ignore Valuation

The biggest mistake that fundamental investors make is to ignore valuation. When the news flow is positive no price is too high for a stock and when the news flow is negative no price is too low. I take a more balanced approach and try to put both good news and bad news into perspective and analyze if it is already priced in.

A stock price is supposed to take into account the prospects of a business many years into the future. However, an unjustifiably large portion of a stock price is dependent on the outlook for the current quarter or year. Over the coming decade there will likely be at least 2 recessions and at least 2 expansions. One needs to remember when the news is good that there will be recessions. One must also remember when the near term outlook is bleak that there will be expansions.

A great example of this short term thinking is investors attitude towards Oracle. Six months ago investors were happy to pay $36 for Oracle. Today they hate it at $25. What really changed? Growth slowed a bit because of the economy, as it has at many technology companies. Earnings estimates for the coming year were lowered by 4%. Oracle still trades at less than nine times these estimates net of cash. A few months ago investors were willing to pay nearly 50% more for this business.

I have little doubt that over the long run Oracle should outperform the S&P 500 as it trades at  a hefty valuation discount.  I would much rather pay a low price for a company when the news is bad than pay a high price when the news is good.

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