Categories
Uncategorized

What I learn from trying to make a stock picker

First of all, it is ridiculously hard. If you think it’s not hard, you either, missed some variables, or ridiculously lucky. The more accurate my simulation gets, the harder it is to find a good strategy. A strategy that works before, may not works now.

Stocks prices are very hard to predict. Finding good company is not very hard. Finding good company at a good price is. The better the company perform, the more people buys it, and therefore the more expensive it gets. The reverse may also be true, but at if a company is performing poorly, it may get even poorer or worst, get delisted, so even if the stock is cheap, its not necessarily a good buy.

Lots of people says that we should look at the intrinsic value of a company to know the fair price. The problem is, what is its intrinsic value? Is it the value if the company is liquidated, or “book value” as it was called? Consider this thought experiment: A company that have a book value of 1 billion USD. However, it does not have any dividend, and it is guaranteed that it wont have any dividend, and it will never initiate stock buyback forever. It is run well enough that it will never go bankrupt or shrink in business, let say in terms of income, but not well enough that it will never grow. What would be the marketcap for this company? Considering that it will never have any dividend, what is the upside to the stockholder? Considering that it will never grow and will never initiate any stock buyback? Why would this company’s stock price go higher? If you know that price would never go up, why would you buy it? Considering no one will buy it, everyone would want to sell it, and therefore the price would fall. But if the underlying company will never go bankrupt and will always remain the same, why would the price go lower? You can say that it is a good hedge, but why choose this over bond which will yield a tiny, but some return? This company is, in some essence, what bitcoin is in terms of intrinsic value.

So, we have establish something. Dividend is an easy… intrinsic value of a company (assuming the company will never get delisted and run well enough). A second factor is harder. A stock’s business must grow. But why must it grow you may ask? Well, if the business grew, the stock price would also grow. That however, is where the complication comes. A stock price is determined by the market. The market is also, trying to make money, and therefore, try to predict the intrinsic value of a stock in the future. Let say the market assume that the sales of the company is the measure of the fitness of the business and therefore it’s instrinsic value, and the price follows the business’s intrinsic value. The market would then want a business that will increase in intrinsic value, as it assume that the price will increase. However, the act of buying the business increase the price of the business, possibly above it’s current intrinsic value. The market would keep buying the business, as long as it’s current price is lower than the future expected intrinsic value. If the current price is the same as the future expected intrinsic value, and the future price of the stock matches the future expected intrinsic value, would the price of the stock increase anymore? If not, why would the market buy the business? If it will, and the market does buy the business, the price of the stock would increase and therefore why would the price of the stock increase?

The back and forth create a balancing act which means, a company’s marketcap usually does not match a company’s intrinsic value. It’s usually match what the expected future intrinsic value of the stock. This causes another question. How far in the future?

Here comes another complication. The future can change, a lot. The further the future, the more chance it can change. Additionally, money now, is more valuable than money in the future. Therefore, the future intrinsic value must be higher than some percentage of current price. Because the future is unknown, there is a chance than the company’s future intrinsic value does not match the expected intrinsic value to break even. Therefore, there is only a certain amount of futureness that the market would be willing to predict. The more stable a company is, the more forward looking the intrinsic value is. However, it also means that the current price of the business will get higher.

This is without considering the fact that some of the market, would also try to predict the future price of the business, instead of just the future intrinsic value. As the future price of the business is likely the predicted future intrinsic value of the business, when predicted in the future, this price of the market would still buy the business, in hope to out-predict those who only predict the intrinsic value, leading to a very high valuation.

In conclusion. I got nothing.

Leave a Reply

Your email address will not be published. Required fields are marked *