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Why stocks' valuation should never be compromised (Lessons from 2020-21 bull run).

Updated: Jan 6

Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.

 


The importance of valuation:

  • I have learnt the hard way that valuation can never be ignored when it comes to equity analysis for long-term investing.

  • During periods of frantic bull runs, many investors (both novice & seasoned) tend to be affected by FOMO and worry that they may miss the opportunity if they do not jump in and ride the bull run.

The stock market rise from March 2020 to November 2021  was one of  fastest bear market to bull market rebound in history (at 77% CAGR).
The stock market rise from March 2020 to November 2021 was one of fastest bear market to bull market rebound in history (at 77% CAGR).


Non-believers on the importance of valuation during bull-runs = people who FOMO.


  • Many journalists & analysts from renowned financial services companies were discouraging the need to perform valuation exercises, claiming it is an "outdated" technique for stock picking.

  • I believe it is likely due to the influence of FOMO,

    • only for them to suffer the consequences later on.

    • fast forward to Oct 2023, the same author ended up teaching & selling a course about valuation now.


  • Cathie Wood who was immensely popular during the same period of time, also disregarded the high valuations of the stocks she was adding to the ARK ETFs.


  • Now has her ARK Innovation ETF performance lower than what it was 5 years ago in 2019.

  • Caveat: however Cathie has always been a proponent of long-term investing, so the full story has not played out yet, we shall see if the fund's performance will exceed its peak in Feb 2021, 5 years later in Feb 2026.

    • which I am quite doubtful it will, since I was not a fan of her strategy of adding some ridiculously overvalued stocks such as

      • Zoom

      • UIPath

      • Shopify

      • Twillioo

        • Some of which may have great fundamentals for long-term business prospects, but their valuation was way too high at the point of her purchases.

Some of the  stocks for ARK ETF where purchased at PS ratio of > 50 and even up to 100X during 2021. (source: ycharts.com)
Some of the stocks for ARK ETF where purchased at PS ratio of > 50 and even up to 100X during 2021. (source: ycharts.com)
  • Even I was a transgressor of this, as I purchased some really overvalued stocks such as

    • Shopify (when its PS ratio was 70X)

    • Datadog (when its PS ratio was 65X)

    • Zoom (when its PS ratio was 62X)

    • Crowdstrike (when its PS ratio was 66X) during early 2021.

    • however, I have since sold these stocks when I understood better on how to value stocks using Price to Sale ratio.


"All intelligent investing is value investing, acquiring more than you are paying for." - Charlie Munger

  • As a long-term investor I strongly believe that valuation is not something to be ignored in the process of deciding to add the stocks into your portfolio.

    • it is never a sound decision to overpay for something no matter how promising their future prospects may be.

Company fundamentals

Valuation

Course of action

Good

Fairly-valued

Good investment, buy

Good

Under-valued

Great investment, buy

Good

Over-valued

Add to watchlist

  • Of course, its a given that the companies' underlying fundamentals must be good for it to be an attractive long-term investment.

Company fundamentals

Valuation

Course of action

Poor

Fairly-valued

Bad investment, avoid

Poor

Under-valued

Bad investment, avoid

Poor

Over-valued

Bad investment, avoid

  • Hopefully this article will serve as a useful reminder in the future when another (inevitable) stock market bull run takes place.


"Those who do not remember history are condemned to repeat it" - George Santayana

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