You guys are very kind but asking the most difficult questions. They are difficult because I don’t think about these things in depth until the questions come up. Some of these like valuation have become second nature and I go by the intuition, so when I have to describe, I have to summon my intellectual mind to put it in words and there are invariably going to be gaps
I read Damodaran on valuation early on in '17 or '18 and I dont think there exists a better book on the subject. People hate him thinking he is all DCF but he is a lot more than that. He forces you to understand the business - the narrative behind the moving parts of the business, its operations, unit economics, capital structure, the competetion, the business cycle etc. If you don’t understand this at an intuitive level, your valuation is going to be way off
You have to somehow get an intuitive sense of how to value cash flows - starting with getting an intuitive understanding of discounting. Understanding time value of money and risk is the first step before you do anything else. Once you do, play around with how an annuity is valued differently from a growing annuity or a perpetuity - again formulas are only shortcuts - you have to get the intuition behind them
A lot of the businesses are treadmill businesses and don’t create tangible value. These businesses are better bought at a discount to book value and sold at 2x book (to me almost all cyclicals fall in this bucket - cement, sugar, textiles, steel, shipping, most financial institutions). There are some you go by replacement cost. Some based on historic P/B multiples. A lot of old mature business in sunset industries that dont have reinvestment opportunities and pay out dividends have to be valued like bonds
Very, very few businesses are franchises and can expand their franchise and have a defensible moat and sustainable margins. These have to be valued as growing annuities and when you discount these less (say 12% instead of 15%) and they grow at a 20% for a prolonged period of time (assumption will vary for each individual depending on their conservativeness) - you will see the wide variations in P/E (based on current year’s earnings) each person will be willing to pay. You will understand a 60x P/E from a 20x P/E and the growth, longevity, margin sustainability and stability they imply
All this is still just assuming there’s some rationality to the proceedings. Often, especially in the short term the market is a voting machine, than a weighing machine. So you may come up with a fair value of x but the price could trade anywhere from 0.5x to 2x and this in itself is a 4x in terms of price range with the business doing absolutely nothing different.
I firmly believe that calling this irrational is incorrect - it is absolutely rational of someone to value staying up to sleeping early (simplest form of discounting we do everyday). We should only observe what market participants think as rational for themselves based on personal preferences without passing judgement (understanding market psychology can give you an edge). Sometimes market can seem to be irrational due to cognitive overload as well (complicated businesses dont get valued highly due to this reason)
We are taught to ignore this by books but it would be foolish to do so. Multibaggers are made when you buy something at 0.5x its fair value and sell it at 2x its fair value and in that period, the business grows its earnings 2-10 fold and worst losses are made when buying something at 2x fair value at the top of the earnings cycle. Read a lot about an industry and its competetive structure, profit pools, policies, moats, individual business journey (ARs, concalls), damodaran on valuation, ainslie on hyperbolic discounting and more importantly, think - there are no shortcuts
P.S. The tone of this post appears preachy as if I have it all figured out. Nothing can be further from the truth. Please note I am also learning these things by writing and thinking about them