As the title of the thread suggests, we are looking at the art of valuation and not the science of it. It is easier to get attracted to hard numbers as they tend to convey a picture of what is happening in the business. However, numbers without a narrative convey only half of the story.
Donald Rumsfeld ( erstwhile US Defence Secretary) had made this quote in the thick of the second Gulf War. He was ridiculed for saying this but what he said has a lot of import for all investors as investing in stocks holds the same kind of uncertainty as war.
“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we don’t know. But there are also unknown unknowns. There are things we don’t know we don’t know.”
Known Knowns )- This ispubliclyavailable data. These are things like revenue, PAT and with a little bit of effort data points ROE, ROIC etc. This is level one thinking and it doesn’t provide any edge to an investor.
Known Unknowns â These are the gaps that one is aware of and can be conquered by diligent research. These are things like industry knowledge, companyvisitsand Q&A. This provides an edge over 90% of the investors who don’t think it is necessary to do the requisite research and draw inference of where the odds lie. This is more like level 2 thinking and provide adiscernibleedge in the markets.
However, the harder aspect of the known unknowns is what this thread is trying to achieve in terms of trying to narrow down some of the factors we think impact valuation of companies in the long term. Liquidity, dividend payout, FII/DII participation etc have been discussed.
Unknown Unknowns â These are the investor blind spots. The size of the box varies from one investor to another. This is the investment journey and comes from experience and a result of the maturation process. The idea should be to keep reducing the size of this box both through self and vicarious learning.
The hardest part is to accept that there are unknown unknowns. However, no matter who you are, this category of unknown unknowns will always exist. Herein comes individual investing characteristics like humility,patienceand discipline. The ability to accept that there are some things about the business or the markets that i don’t even know that i don’t know.
As Donald very rightly puts it,have faith that i have done all that i could have done in terms of my research and now the best thing i can do is to sit tight and wait for the story to unfold. We tend to over analyse every piece of news coming out and every quarterly result. This noise at times drowns out the signals and we end up taking decisions that we shouldn’t.