I am a sucker for algorithms that simplify my life. When it comes to investment analysis of thousands of companies I find a simple rank-sort helps me prioritize from a nearly infinite set of possibilities.
Step 1: Value the business. (this is where all the work is.)
Step 2: Estimate the price.
Step 3: Divide price by value. The result is Margin of Safety in percentage form.
Step 4: Rank-sort the Margin of Safety in descending order.
Step 5: Focus time on top of the list. What did I get wrong? (this is where the money is made.)
Step 6: Update with better assumptions.
The result of this infinite loop is doubt is amplified in the right place. You must drill into the underlying assumptions associated with the base values. This is healthy and good. Is the foundation solid? Do you trust it enough to act? Many people see work and pain and retreat to the comfort of the crowd. For me, the joy of discovery and realization of a job well done comes from my own peace of mind… I know I did my best on sound reasoning. My worth is not found in the opinion of other people. (side note: my father taught me: “it’s amazing what you can accomplish if you don’t mind looking like a fool.” As a teenager, I thought this meant acting goofy. As an adult, I think he was saying, ‘Do what is right regardless of the crowd.’ My father lives this way and is adamant about cutting through the crap. Thanks, Dad.
Go back to the assumptions and challenge yourself. Are you thinking about the company properly? In which direction should you error? I find that if I start layering on conservative assumption one after another I either knock the company/idea out of the top of the list, or the idea starts to crystalize in my mind.
This week Colin merged in several of his public company ideas into this simple rank-sort algorithm and “things got interesting.” We wound up with Public, Private, Private, Public and on down the list…
I’ve told people we are professionals at comparing apples to oranges. This is one of the ways we do it at scale.