Tuesday 2017-01-24

Bronte has a recent post stating that Hempton doesn't create exit execution plans because many errors can accumulate when forecasting the evolution of a company's market valuation.

One of the commenters hits on a very good reason for planning:

I once worked for a fund whose analytical process was very centered on valuation. We derived weighted average estimates of intrinsic value. Here is what I found:

(i) the process of estimating intrinsic value was more important than the results themselves
(ii) while the head PM valued, and insisted on rigorous DCFs, as key part of our firm's process, I foudn that their behavior was more complicated: often tiems they didn't trust what the in-house DCFs were saying..

-- January 3, 2017 at 12:39 PM

One can say the same thing about VaR, in that the value isn't in the number itself, it's in the processes behind generating the number.

However, with valuation there's an additional reason: since intrinsic value eventually wins out, we can use our past predictions to improve our future predictions. The more outcomes we define, and more times we put probabilities and confidence levels on them, the faster we can improve.

Finally, another commenter touches upon the biggest reason: we want to be able to manage negative changes.

Note also that the KO valuation in 1998 was $165B compared to $178B today (the FOMC can only do so much), leaving any return in the past 20 years largely to dividends...

The 1998 annual report proudly notes:
«A $100 investment in our Company's common stock on December 31, 1988, together with reinvested dividends, grew in pretax value to approximately $1,365 on December 31, 1998, an average annual compound return of 30 percent.»

-- January 4, 2017 at 12:03 AM

Flip the goal of investing from money-making to loss-management. This is akin to running a reactor that outputs earnings while the power excursions are drawdowns. While we monitor the output, what we really care about are the power excursions -- i.e. keeping them within an expected band: too little and the reactor could be generating more output, too much and we melt the core.

Since the core isn't monolithic, as parts of it exceed tolerance we have plans in place to either moderate or remove those elements. In the worst case scenario, we need to be able to scram the reactor, and so need those execution plans for every element of the core.