Many new investors make the mistake of thinking that just because a business has sold off significantly that it must be trading at a discount to its intrinsic value. This is not the case. In fact, most of the time, the sell-off will be warranted. Businesses deteriorate over time. They grow slow, stagnant, comfortable. Then something or someone comes along and disrupts them. Or maybe the market grows competitive. Or the financial landscape changes. There are an infinite number of reasons a business can fail. The point, though, is that failure is the expected outcome. It is therefore not sufficient analysis to observe that a stock has sold off significantly and buy-in, thinking that you are getting a deal. You must understand the business, understand why it has sold off, hypothesize on the mechanisms for why the market is in fear, or doubt, and then think about why it may or may not be wrong. Only by understanding the intrinsic value of the business, and perhaps the weighted probabilities of possible outcome for the business can you be reasonably sure that the business is truly undervalued or just another impaired asset.
Connections
Link Explanation: This is an interesting connection. The linked note discusses the idea that a high price, P/E ratio, P/FCF, however you want to measure it, is not necessarily over priced. Great businesses deserve their high valuation and a high price does not mean it is not a good buy. Likewise, as discussed in the current note, a low price does not automatically mean that the opportunity represents value. In both cases it is important to do the hard work. To actually understand the business to the best of your ability and form your own independent assessment of its intrinsic value. Only then can you look at the current price and judge whether it is over priced or under priced.