The Dirty Little Secret Investment Professionals Know That You Don’t

It’s all made up.

That research report your broker just emailed you about the next Amazon?

Pure fiction.

Those elaborate financial models forecasting earnings out 5 to 10 years?

Balderdash. 

The case for the next ten-bagger being cheap? 

Malarkey.

Wall Street research looks impressive and sounds confident. But just because you calculate a price target with seeming precision doesn’t mean you aren’t trying to do the impossible, i.e., 

Predict the future with 100% accuracy and certainty.

We all know the probability of that being true is 0%. The only thing certain about the future is that it’s uncertain. And the further out into the future you go, the more uncertain it is.

Let me explain.

The core valuation technique of modern finance (Discounted Cash Flow or DCF) posits that a stock’s valuation should be the present value of the future stream of a company’s free cash flow. In other words, you take the future cash generated and discount it back to the present.

Here’s another way to put it: Think of a company as a money printing press. How much money will it print over 10 years? And how much am I willing to pay today for the total amount generated over a decade?

The answer to both questions? It depends.

You could take the cash flow over the past 10 years and assume it’ll be the same going forward. But is that likely? Might be more, might be less. You tell me what the competitive, tax, regulatory, technological, operational, labor, and legal landscapes will be over the next decade.

Companies do not operate in a spreadsheet vacuum. 

They operate in an economic and societal landscape that is ever-changing. So whatever you input for your growth rate, however well thought out, is nothing but a wild-ass guesstimate.

To add insult to injury, the discount rate (interest rate), the other critical input into the DCF calculation, will go up and down over time.

Here’s how to think about it. 

How much would you pay today for the value in 10 years of $100, growing 10% annually ($259)? 

At today’s 5% discount rate, modern finance theory says you should be willing to pay $159. 

At 3%, $192.72. 

If rates were to go up to 8%, $119.97. 

That’s why stock valuations kept climbing higher as interest rates declined from double digits in the late 70s/early 80s until they bottomed out in March of 2022. The lower the discount rate, the more you’re willing to pay for the future value of money.

My point is not to make your head spin.

It’s to show that the reason stocks gyrate so much is that investors are constantly fiddling with a stock’s valuation whenever rates or cash flow estimates change. And yet, over the long haul, no one, pro or amateur, has a clue. 

Formulas are notoriously bad at predicting the future.

Investors may tweak prices constantly to account for valuation changes in the near term, but that doesn’t make their long-term forecasts any more accurate. It’s very easy to get caught up in the hamster wheel of updating your price targets for a stock, based on operating results and interest rate changes. Just don’t mistake all those corrections for precision. 

Pros are no better than you at predicting the future. 

They just have a better grasp of jargon, spreadsheets, expectations, and the impact of news flow on stock prices. At the end of the day, investing is about handicapping the odds and trying to quantify the unquantifiable. In the short run, stock prices can appear to be reacting rationally to news but in the process, end up with irrational long-term valuations.

What’s my point?

1. Get comfortable with uncertainty, the only certain thing in life.

2. Invest for the long-term.

3. Use short-term, temporary price dislocations that don’t affect the long-term value of a business franchise to add more to your positions or market exposure.

4. The more confidence someone has in their prediction of the future, the more skeptical you should be.

Send me your investing questions, or let me know if you want to read more of my thoughts about investing. I read every email you send me!

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Three quick and easy resources to be a better steward of your money:

The Three Bodhisattvas of Finance

Safety, and Clarity are needed to take Aligned Action when it comes to managing your money.

Jizo, Manjusri, and Daruma embody those qualities, and will inspire you to feel more grounded and confident in your decision-making.

Each week I show you how to cultivate each step.

JIZO: Safety and Acceptance

Here’s a quick and easy way to feel less anxious.

Think of anxiety as an electrical storm raging in your brain. It’s contained to one hemisphere. So pass an object from hand to hand across the midline of your body for a few minutes. 

When you do that, both brain hemispheres will be activated. This is known as bilateral stimulation, and because your whole brain is engaged, your anxiety “storm” can no longer maintain its intensity.

I learned this technique from my brilliant hypnotism teacher, Melissa Tiers.

MANJUSRI: Clarity and Discernment

One way to connect to your inner desires in defiance of peer, familial, or societal pressure is to learn from those who made it a lifetime practice, like Steve Jobs.

Here’s a free collection of Jobs’ speeches, interviews, and emails.  

Following your own path is not easy. 

Take heart from those who have gone before you.

DARUMA: Action and Resilience

If you’re having trouble taking financial action, here’s something that can help you even as you lie in bed, worrying.

Watch Ramit Sethi’s How to Get Rich on Netflix.

He uses many different strategies to get people to start taking action. You may find one that gets you off your ass!