Investors or business people who might be reading this piece will find our views interesting and a little contradictory. We will tend to talk about valuation-based models, and we will also talk about why they won’t suffice in the current dynamic Indian market environment.
So while reading Narrative with Numbers by Ashwath Damodaran recently, I really got intrigued by the concept of looking at the narratives rather than only the numbers behind stocks or businesses in general.
There are mainly two types of ways we can value a company or a business, either by looking at the company’s operations, its products or services, customers, management, etc or looking at the numbers which drive the business’ valuation (measured through traditional portfolio management) like profits, revenue, return on invested capital etc.
In this piece, we will be talking mainly about the former by explaining as in why the number crunching alone will not work. If we notice properly, the stocks that have got hammered recently by the market like the Sun Pharmaceutical (poor corporate governance), DHFL or the IL&FS default etc if viewed holistically can give us a better picture of the problems that were present or crept in these (and other) companies. Inculcating additional points like talking to management, looking at the company’s history, management past and present decisions that are running the company, corporate governance practices, its products and services and intelligently forecasting how they will fare over the long term can be quite beneficial for your investment.
A disclaimer here should be mentioned strictly that both qualitative and quantitative forms part of fundamental analysis.
Just to be frank with you all that what is explained in this blog is difficult to implement practically and can require lot of time and efforts. Quantitative analysts who tend to only deal and consider numbers use variety of numbers incorporated in valuation models and hence find what is known as the intrinsic value. This will particularly not be a single number but a range (which is the usual practice). These valuation models can range from discounted cash flow models which comes under absolute valuation models to price to earning ratio which comes under relative valuation models. We will not look further into these in this blog.
What we are trying to make you understand here is that if we ask people who are actually aware, they can also tell you that advancing technology will soon overcome tasks which are being performed by humans or in this context traders or other market participants. What will be difficult for machines will be the emotional or the ‘gut’ part of the human cognition. How we can trust and see the qualitative nature of the business like the products and services (no! not talking about the sales or any number part but how and why customer adopt the product, what particular feature they like etc etc), the goodwill of the company. When looking at the company try to form a story as in how do you think the company will move towards its mission (can be found in the annual report), its strategies and the ways to achieve both short term (typically less than 3 years) and long term (more than 3 years) objectives, how do you think the company can translate these into its number (quant investing comes into perspective). I am not telling you anywhere in this brief that you should not see the numbers but what you should look towards is a ‘dynomo’ investing (sincerely coined by the author :D) that try to think about the narrative that can be played out in the future and keep a tab on the company regularly and fine-tune your story and the numbers simultaneously.