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JakilaTheHun (99.92)

The Stupid Call: How I Became Overconfident



May 08, 2009 – Comments (5) | RELATED TICKERS: PEGA

Over the past year, I have slowly but surely become better and better at valuation.  Most of my stock market success can be attributed to that.  What's more --- I've become extremely good at coming up with relatively accurate valuations in a very small amount of time.  Many people will spend hours created very complex DCF spreadsheets --- I have a form that I call the "Quick DCF".  It's a DCF, but I only need to plug in a few figures (e.g. cost of capital, long-term growth rate, initial free cash flows, net value of assets).  I've been able to derive the figures for this spreadsheet in a more rapid fashion over time.  In fact, lately, I've been making some stock picks on here with 10 minutes of research.

While I am right 65%+ of the time doing that, that's not enough.  This is part of the debate in my head over the most efficient way to invest.  I believe you are most likely to find the best buys by analyzing as many companies as possible.  IMO, this is vastly more cost effective than taking a huge amount of time studying a few companies in detail.  But it looks like I've hit the point where my accuracy suffers enough so that it's not "cost effective", so to speak.  If I spend 30 - 60 minutes researching and analyzing companies, my success rate on my picks probably jumps up to 80%+. 

The company I made a big goof on: Pega Systems (PEGA). 

Yesterday, after my quick 10-15 minutes of research and analysis, I concluded it was a great red thumb.  This morning, I decided to look at it again to write my pitch.  Uh ... what can I say?  I screwed up.  The extra 15-30 minutes of research yesterday would've saved me from this reverse of course.  Hey, I learned my lesson at least :)

If you want to read my rather humbled pitch on PEGA, click below:

Maybe this is a good thing.  Everyone needs to be humbled occasionally.  Maybe I'll even luck up and get out of this pick with a positive score. 

Just for the record, I'm not suggesting that anyone who red thumbed this pick is "stupid".  Maybe those who red thumbed it had better insight than me on some issues with the company or simply believe it's due for a technical retreat.  Everyone has their own way of analyzing things and that's fine; I don't claim to be superior or inferior to anyone else.  My main issue is that I got careless and lazy and betrayed my own analytical process.  If I had studied this stock a little closer the first time, I would've stayed neutral on it, but expected it to rise towards $30 at some point in the future (not enough to make me green thumb it w/o further research, though).

Heh, guess I can hope for a +5 score on next Friday when I have my first chance to end it.

5 Comments – Post Your Own

#1) On May 08, 2009 at 9:56 AM, finabuddy (80.98) wrote:

Why are you doing a DCF for a company like this? Especially a "quick" DCF. I suppose the ways to take shortcuts are on the discount rate and terminal year, but those are crucial. What is your terminal year method-some multiple or a gordon growth number? Usually you only see DCF as the primary valuation method used by the market for high growth or pre revenue companies (E.g. biotechs, speciality pharmas) Are you creating a football field to support your DCF valuation? My advice would be that if you are going to do a technical analysis you should consider a couple things. 1. DCF is going to be the most subjection to "junk in junk out". If you dont vet your inputs and spend some time considering your assumptions it isnt going to be reliable. You should look at M&A transaction multiples and trading comparables as well to further support a price target (p/e, fwd p/e, current and fwd ev/ebitda ev/revenue are very common). Finally, read some thomson reports. How are equity analysts creating a price target? in your pitch you looked at P/B, but how are its peers? Is p/b an important multiple for application software business (probably not).

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#2) On May 08, 2009 at 11:03 AM, JakilaTheHun (99.92) wrote:


To be honest, I don't find your advice that helpful.  Everyone has their own methods.  The advantage to my methods is that it allows me to come up with a ballpark valuation for a wide variety of companies in a very quick time frame.  Because of this, I'm able to analyze more companies than most people and able to find better deals than most people. 

I've seen people use ridiculously complex valuation methods over and over and over again and they constantly convince themselves that they are somehow superior to vastly simpler methods.  If I were running a private equity firm and making a $200 million investment in a company --- the quick DCF wouldn't be very good.  But for analyzing stocks, it's great.  My method is simple, but it requires maybe about 30-45 minutes research worth on the inputs to maximize its effectiveness.  Sometimes, I can do less if I understand the industry well, but that's where I got burned on this company --- I really should have spent more time on them.

My Quick DCF relies on coming up with informed estimate ranges of added value, formulating various scenarios, and fiddling around with the numbers to see how they affect valuation.  IMO, when you are valuing stocks that you plan to buy for small purchases, you really need no more than a ballpark range.  People can spend hours crafting a DCF and they won't be more significantly more accurate than my skeletal barebones DCF --- something I've verified by watching others use these more laborious processes.  That's why my method is more effective than most --- it's cost efficient.

I can actually come up with a ballpark initial valuation in 3-5 minutes.  That's what I normally do first.  If it looks intriguing, I begin researching further and taking a hard look at the financials. 

Not sure why everyone believes you have to have a ridiculous number of inputs for a DCF --- it's like people are taught that in school and unable to break away from it --- yet, they'll talk about P/E ratios in the same sentence without realizing the contradiction.  The Quick DCF is a much better guide than examining P/E and P/B ratios.  It's quick, simple, and effective.  Though, I normally do look at P/B ratio first before even jumping to my Quick DCF spreadsheet.


If you ask me, the most important thing to understand with valuation is this --- it's not whether you're right or wrong.  You're "wrong" --- stop convincing yourself otherwise.  The best thing you can do is understand the flaws to the model you are using, compensate and account for them, and understand how changes would impact the valuation.

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#3) On May 08, 2009 at 12:42 PM, finabuddy (80.98) wrote:

 I was more curious on the specifics of your dcf or your theory rather than its just faster. I absolutely agree that more laborous DCFs arent gaurnteed to be more accurate, but primarily because of the quality of the inputs themselves. What is your barebones discount rate and terminal year calculation? 

 I am absolutely on your side with doing an analysis as youve already suggested, you are looking for support  in a ballpark range (ei football field as I refered)

 I dont think there is a wrong or right way, I believe the best way to approach valuation is to find the most supported way or do all the methods for a complete picture. A DCF method is undoubtfuly the best way to look at some companies with estimated large increases in future cash flows. The only thing I dont agree with is the one size fits all mentality. I suppose it works if you are curious if the market has a huge unwarrented premium/discount on the company that isnt supported by the projection cash flows.I dont know what other DCFs you are refering to, or who you watched, but I just dont understand the logic between dismissing those on acedontal evidence while touting your own which is again, a one size fits all. I imagine you are smart enough to make good investment decisions regardless of what your DCF tells you and is enfluencing your perception. I think its a baised assesment at others' technical analysis.  


However, it is refreshing to see someone talking about a techinical analysis that actually took some thought. Just looking for some spirited debate on methodology!



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#4) On May 08, 2009 at 1:40 PM, JakilaTheHun (99.92) wrote:


How is my DCF a "one size fits all"?  You seem to be making a lot of assumptions about it and my method of valuation.  It's not like the Quick DCF is the only tool I use.  I normally place more emphasis on balance sheet accounts than I do cash flows.  But after I value assets, it's pretty easy to plug that into the DCF.

I'm not sure what you mean by "technical analysis" either.  When I hear the phrase "technical analysis", I tend to think of people who stare at charts looking for trends.  Those aren't terribly relevant to me; my investing style would be the absolute anti-thesis of "technical analysis".  I have no faith in my ability to "time the market".

Discount rate depends on the circumstances.  I normally use 8% - 12% for an initial quick valuation --- I pick the rate by industry and leverage.  After doing some research, I'll oftentimes modify that figure --- or sometimes, I'll use different discount rates --- like I said, the most important thing to me is understanding how different inputs affect valuation.

Terminal value is normally between 3% - 5%, but I often mess around with FCFs/added value for the first few years. 

There's nothing particularly precise about my quick DCF.  It's just to give me a very quick idea about a range the stock should be trading in based on the fundamentals.  I want to know how various inputs and changes in circumstances might affect valuation without spending hours. 

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#5) On May 08, 2009 at 1:50 PM, JakilaTheHun (99.92) wrote:

Terminal value is normally between 3% - 5%, but I often mess around with FCFs/added value for the first few years. 

That should read "long-term growth rate" is normally between 3% - 5%.

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