Driving into Stock Analysis: The Used Car Approach
How Intrinsic and Relative Value Drive the Search for Undervalued Companies
Hey there!
I’m thrilled to be back on your screen.
Last week, we unknotted the mystery of the five numbers that tell you which stage a company is in (click here if you haven’t read it).
If you’re new here, welcome aboard! If not, you know what to do.
I’m Michael, your friendly stock guy, and I’m on a mission to make stock evaluation as easy as choosing your favorite ice cream.
Last year, I embarked on a wild journey to create a program that does the heavy lifting when it comes to stocks. Curious about my wild escapades? Read the full story here.
The meme generators is not availabe, so I have to skip it this week …
Now, let’s poke deeper into the captivating world of stock analysis.
There are two major teams in the stock analysis game:
Two people are a team
Technical and fundamental analysis
The former attempts to predict stock price movements, while the latter looks under the hood of a company. The goal of fundamental analysis is to determine if a company is “good,” which can be reflected in its stock price.
However, even brilliant companies can sometimes see their stock prices tank. Blame it on incorrect assumptions or Mr. Market’s insanity – it happens.
Fundamental analysis has a second objective: to find brilliant companies that are undervalued.
What does that mean?
Who doesn’t love getting a dollar’s worth for just fifty cents?
If you agree, read on.
To perform a fundamental analysis, we search for value drivers – factors that make a company more valuable by providing more value to its customers.
Surprise, surprise!
It all starts with numbers. We won’t get bogged down with the nitty-gritty math in this article; the goal is to help you paint a mental map so you can navigate yourself. When it comes to numbers, there are two camps:
Intrinsic Value and Relative Value
Think of intrinsic value as inspecting a used car to see if it’s a good deal. You check the mileage, accident history, rust, oil service, and other technical factors. In contrast, relative value is like comparing the car’s price to similar cars on the market.
If the car is in good technical shape and is cheap compared to its peers, you might have found an undervalued gem.
But what if the car has a modified engine or other features that make it difficult to compare to standard cars? That’s where the magic of statistics comes in – helping us cut through the noise to make even the most unique car (or stock) comparable.
Now we’ve covered intrinsic and relative value, but there’s more to the story.
Alright, buckle up!
But there is more …
Picture this: the car checks out in terms of numbers and technical aspects, but what if the previous owner was the type to floor the gas pedal every morning, even in the frostiest winter conditions? Can the engine really handle that kind of abuse?
And let’s not forget about the car manufacturer releasing a new model. Will that cause your car’s price to plummet? Should you pump the brakes and wait for the price to drop before making a purchase?
Decisions, decisions!
It’s the same with stocks.
Several factors influence a company’s value. There’s no right or wrong when it comes to what to look for during analysis.
A few more things to consider
1. Are you familiar with the industry aka the specific car model?
2. Do you have insights that others don’t have?
3. Can the company keep existing customers and attract new ones?
4. Does the company have a strategic advantage that’s hard to copy (a “moat”)?
5. Who is invested in the company? Are there conflicts of interest?
6. Is the management team skilled and responsible?
7. Does the management work in the shareholders’ best interests?
8. How do regulations affect the company’s profitability? (Macro)
9. Can the company secure affordable loans to grow its business? (Marco)
These are just a few examples – there are countless factors to consider.
The takeaway meal is this
Both direct and indirect (Macro) factors impact a company’s profitability and therefore, its value. And as you navigate this interesting landscape, always remember: there’s more to learn, and that’s what makes it all so exciting!
Weekly Update Days until the end of 2023: 240
Quote of the week
“Sometimes you have to go slow in order to go fast.” – Mario Andretti
Hold up!
There is one more thing.
I’m pumping the brakes on coding for a moment, as I’ve come to realize that I need to explore some more profound concepts before charging ahead.
It turns out there are several steps that can significantly boost the accuracy of my fundamental output, and, as I’ve mentioned before, statistics move the needle.
I began calculating averages for specific sectors and industries, but then it hit me. I can’t just barrel through it and end up facepalming myself, thinking, “Oops, I messed up.”
Nobody wants that, especially when my goal is to craft fine code with a strong output. Admitting when you’re walking in the wrong direction is crucial, and as long as you learn from it, being wrong is okay.
So, I’ve decided to take a scenic detour, slow down, and immerse myself in the bigger picture until I’ve grasped every essential detail. That’s the way to truly make some magic happen!
Progress:
• Delved into the world of multiples and the impact of statistics
• Completed my AI homework
• This sucked. I canceled my trip to Croatia because of bad weather.
Plans:
• Learn more about multiples
• Write the next article
Where is my head?
My little sister turned 30 this week, and my dad turned 73 the following day. As I grow older, I find myself cherishing the time spent with loved one’s even more. The conversations become deeper and more meaningful, making time fly in the best possible way.
Conclusion
Fundamental analysis can be both complex and exciting. As you dive into the numbers and explore intrinsic and relative value, remember there’s always more to learn.
It’s a journey filled with twists and turns, but the rewards can be tremendous – like finding that undervalued gem of a company (or car) that turns out to be a fantastic investment.
So, buckle up and enjoy the ride as we continue to hit the thrilling roads into the world of stock analysis together.
Don’t forget to share your own experiences and thoughts with me!
Until next time, keep learning, stay curious, and embrace your day.
Catch you next time!
Michael
Disclaimer:
The information in this article is my personal opinion. It is not consulting, nor does it constitute investment recommendations.
I do my research carefully and follow my personal investment strategy.
The stock market is a complex building with its own rules. They are no rules set in stone, like the rules of physics.
Therefore, use the contents of this newsletter at your own risk. Investing in the stock market can always lead to a total loss of the capital invested.
It is really great comparison with cars, I like it. Thank you.