Why Some Stocks are Cheap & Others Expensive | Summary and Q&A

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March 20, 2023
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The Swedish Investor
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Why Some Stocks are Cheap & Others Expensive

TL;DR

The stock market values companies based on their historical revenue growth, reliability, financial stability, dividends, profitability, and future earnings growth.

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Key Insights

  • πŸ“ˆ Revenue growth is perceived as the most important metric when valuing companies.
  • πŸ₯Ί Reliability, in terms of consistent revenue growth, leads to higher valuations.
  • πŸ“ˆ Financial stability, dividend payments, and moderate impact on valuations compared to other metrics.
  • ❓ Profitability, particularly gross margin, significantly affects a company's valuation.
  • πŸ§‘β€πŸ­ Return on assets does not seem to be a major factor in the stock market's valuation process.
  • 😘 The stock market expects mean reversion and values companies with higher or lower margins accordingly.
  • ❓ Future earnings growth projections heavily influence valuations.

Transcript

I’ve just examined 5358 publicly listed companies from all over the world so that you can understand what the stock market values in 2023. But first a little intro – why should an investor care about this? Mr. Market is an analogy that β€œthe father of value investing” Benjamin Graham invented in his 1949 classic – The Intelligent Investor. Mr. Marke... Read More

Questions & Answers

Q: What is the most important metric according to the stock market when valuing companies?

Revenue growth is deemed the most important metric, as companies with a consistent increase in revenue are assigned higher valuations.

Q: How does reliability affect a company's valuation?

The stock market values reliability and assigns higher average P/E multiples to companies that consistently increase their revenues over the years.

Q: Does financial stability impact a company's valuation?

Financial stability, such as having a net cash position, slightly increases a company's valuation, but the impact is not significant.

Q: How does the stock market view dividends when valuing companies?

While the stock market appreciates dividends, it is not obsessed with them. Companies that pay dividends have a slightly higher average valuation, but it is not a major factor compared to other metrics.

Q: How does profitability influence a company's valuation?

Profitability, especially gross margin, significantly affects a company's valuation. Higher gross margins lead to higher valuations, indicating better survival during downturns and potential economies of scale.

Q: Does the stock market consider return on assets when valuing companies?

Return on assets does not seem to be a significant metric in the stock market's valuation process, suggesting a possible short-sightedness on the market's part.

Q: How does the stock market value companies with different margins?

The stock market expects mean reversion and values companies with higher-than-usual operating margins lower, while companies with lower margins are valued higher.

Q: How does future earnings growth impact a company's valuation?

The stock market heavily relies on forward estimates provided by analysts, with companies projected to have high future EPS growth assigned higher average valuations, and those projected to experience decreased earnings valued lower.

Summary & Key Takeaways

  • The stock market values revenue growth the most, considering it the most important metric to assess a company's value.

  • Reliability is highly valued, with companies that consistently increase their revenues being assigned higher average P/E multiples.

  • Financial stability, such as having a net cash position, slightly increases a company's valuation.

  • The presence of dividends influences valuation, but it is not a significant factor compared to other metrics.

  • Profitability, particularly gross margin, greatly impacts a company's valuation, with higher margins leading to higher valuations.

  • Morning than usual profitability margins are undervalued, while unusually low margins are overvalued.

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