Assessing Valuation Risks

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Many, many super geniuses are certain that mathematical modeling can predict a portfolio’s maximum possible loss. But they really can’t eliminate the zone of ignorance–that is, what is going to happen in the future. In the words of valuation risk investor Howard Marks:

“The probability of loss is no more measurable than the probability of rain. It can be modeled, and it can be estimated (and by experts pretty well), but it cannot be known”

At Punch Card Research, we are well aware that we cannot know the future. We know that the analysis of risk valuation is, at best, freak-economical. We do, however, know two things:

  • The return on any stock is determined by the relationship between the price today and its future cash flows.
  • Those future cash flows will reflect the basic performance of the company, as well as the price if its stock as a result of that performance. and the way its stock is priced given that performance.

But we should not fool ourselves by thinking that if a return meets or exceeds our expectations, we’ve bet on the right horse, period. We might have just lucked out because of influences that were unknowable when we invested. We might just as well have lost money because of influences that were unknowable when we invested.

The bottom line for Punch Card Research: Is the price we are being offered for this asset reasonable in relation to the future cash flows it will throw off? Minimizing this risk is at the heart of value investing.

We want to only purchase assets that the market has mispriced for whatever reason. Luckily, the stock market creates many dislocations between price and value. We keep an clear eye on them.