Short-term view coupled with Long-term view

Got me thinking in this bear market about a short-term and long-term view. Value investors have the mantra: take a long-term view and purchase the stock when it is trading at a significant discount to the intrinsic value.

Not that there are any flaws with regards to this idea. But problem lies in that, for e.g., u apply a 10-yr DCF for a certain company and u arrive at say, $5. So, if you apply a significant MOS, say 50%, you should purchase it at $2.50. But as everyone might have been aware, this might have left you smarting with some losses at this moment of time. Simply because the markets are viewing it more bearishly say at $1.50, largely because of the fall in their short-term earnings.

The natural response might be to average down your cost, some might say. If the MOS was applied, the losses might not have been huge at this moment of time, and all you need to do is to dollar-cost average your way down. But, let's be a little realistic here. We're retail investors. How deep are your pockets? you've got $200,000 more? $1 million more? There's going to be an extent to which you can average your way down.

How now? Do we still stick to this principle? Of course! But, we need to understand that the fundamentals do change with the macroenvironment. Do we apply a larger MOS? You could. But what I think could work better is to find out how much of earnings downgrade the market is factoring in. The ways to do this will not be covered for now, but a simply suggestion(but highly inaccurate) could be to predict the earnings next year and apply a suitable PER. Most importantly, the concept lies in that one should know what this short-term price, that the market values the security currently, means. This will help to limit your downside, probably, and after you've factored in some earnings downgrades, back to the principle, do apply a MOS as well.

Now, the difficulty in this lies in that earnings cannot be predicted so easily. If it could, we would have all been rich. There are probably 2 ways to do so:

1) refer to analyst estimates and consensus estimates

2) look at how the company has been performing previously in crises, and predict the earnings from there.

I try not to use 1), not because of overconfidence that I'll predict better than the analysts, but only because they tend to try to be accurate, but value investing is all about being roughly accurate, because it is indeed very tough to be highly accurate. When you try to do that, chances are that you might make mistakes somewhere by failing to account for itsy-bitsy pieces of information. For now, I've been trying to apply the 2nd methodology. Of course, companies change with time. The $5 stock I mentioned could be much more robust now than in previous crises, possibly because of a regional franchise, or larger sources of revenue. But the macroenvironment could be different based on the previous crises (i.e. Sars and Asian Financial Crises). That's where the MOS comes in handy.

Now, how much of earnings downgrade to factor in will alter your pick-up price. Then, the question comes. What if you've factored in too much an earnings downgrade, or too high a MOS? You could miss picking up the stock because of that. I can't answer this question, but for myself, what I do is to make a reasonable earnings downgrade, and apply a smaller than usual MOS only because you have subconsciously applied an MOS when you did your earnings downgrade. Will this method work? I'm not sure. Try calling me in a few years time to see if I've moved to a larger bungalow or mansion. But worth trying? Maybe.