Mental Models discussed in this podcast:
- Margin of Safety
- Price vs Value
- Time Value of Money
- All Else Equal
- First Principles
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Low stock prices are better than high stock prices (Investing First Principle) – Show Outline
The full show notes for this episode are available at https://www.diyinvesting.org/Episode33
It is preferable to purchase stocks at low stock prices for 2 key reasons
- The margin of safety is higher (What happens if you are wrong)
- Potential Return is higher (What happens if you are right)
Relationship between Price and Value
- Value investing, at its core, is all about purchasing assets for less than they are worth.
- Price represents what you pay
- Value is what you receive
- Obviously, the lower the price you pay, the better the outcome. (Regardless of the value you actually receive)
“All Else Equal” considerations
- Time Value of Money – You can’t directly compare the stock prices across time. (ie. today versus the stock price one year ago.) It’s quite possible that it makes sense to pay a higher price today than it did a year ago if the value has increased.
- Variable Business Quality – Some businesses are of higher quality than others. You can’t directly compare one company’s P/E ratio to that of another. A high-quality business might be worth 20x P/E while another business is only worth 10x P/E. It would be a mistake to assume the 10x P/E company is a better deal.
- Variable Growth Rates – Some businesses have the capability of profitably growing their earnings, and others do not. Those with profitable and sustainable growth in the future are going to be worth more. You can’t directly compare P/E ratio’s in that circumstance.
- Industry Differences – some industries are more attractive than others
The scope of this first principle is limited to simply understanding that your goal is to purchase the highest amount of present and future earnings possible. The way you do this is by paying a low price for those earnings.