If the Central Banks got it wrong on monetary policy, can we also assume that the valuation models that we have done and relied on for the last two decades are also flawed?
Though hard to mathematically quantify, truth is: Liquidity drives a huge part of value. Put simply: an asset is only as valuable as the next guys who wants it. Against the current backdrop of monetary tightening to fight inflation and funds becoming more cautious about their investments, asset prices seem to have reacted and dramatically fallen.
Growth is another key driver of value - which in this case, is being eroded by rapid inflation, adding to the further discount in prices. The double whammy here is that the same high growth companies that sold astronomical prospects of the future will face the real test over the next two years as they fight against a policy that encourages the cool down of the economy.
Is there a playbook to rectify this? Was it an error on the part of Central Banks when QE was introduced in the aftermath of the 2008 financial crisis? Did early bitcoin and cryptocurrency adopters see this gradual erosion in the value of money coming? I'm not sure.
Most of the existing infrastructure we know is build around a set of 'stable' economic assumptions. Capex for power grids and oil exploration / refining (which are easily 10 to 20-year projects) have been traditionally modelled around $60 oil. Cap rates for real estate (another presumably long term asset class) are largely driven by interest rates. Likewise with breaking down the cost of any manufacturing plant, which is driven by the input prices of raw materials including commodities. The world just cannot absorb the sudden change in prices that would dramatically disrupt these economic models that we have relied on for many decades.
Beta quantifies risk by measuring the standard deviation of an asset price against a reliable index benchmark over a long term dataset - the key word being long term. Furthermore, assuming that the immediate future would follow a reversion to the historical long-term would be borderline laughable given the current state of world affairs.
So if we can't rely on beta and the pricing assumptions of today, the best thing to do is to probably wait it out until the world finds some sanity (and stability) amidst the current circus of events.
Bankers and financial professionals try to measure risk and returns using all kinds of academic and empirical bases - NPVs, IRRs, weighted average cost of capital, etc.
I introduce to you a new way of looking at risk: How much are you willing to lose?
Say you pay $10 to flip a coin. Heads: you get double the amount ($20), Tails: you walk away empty-handed. Now consider that it'll now cost you $1,000,000 to do this. Would you still take the chance?
Mathematical models involving the calculation of risk unfortunately omits the element of human emotion. For many investment decisions in Asia and other emerging markets, emotion is often a huge part of what drives the deal. This is probably the single biggest reason why your complex DCF and bullet-proof-calculated discount rates don't weigh very much in this part of the world.
Mispriced deals exist all the time because the stakeholders can't accept what they possibly could stand to lose.
Consider a scenario in which a business owner will never relinquish a partial stake in the company to an incoming buyer who has plans to break up the assets and change its corporate direction. Or a seller signing off on an under-valued transaction just to close the deal because he/she can't live with the possibility that there might not be another better offer on the table.
All risk models break down when you have everything (or nothing) to lose. Managing it gets easier when you are more diversified and don't go to the negotiating table with an all-or-nothing mentality.
The next time you are presented with an opportunity that offers a certain rate of return, think: what are you prepared to lose?
“Rome wasn’t built in a day but they were laying bricks every hour.”
"The problem is that it can be really easy to overestimate the importance of building your Roman empire and underestimate the importance of laying another brick. It’s just another brick. Why worry about it? Much better to think about the dream of Rome. Right?
Actually Rome is just the result, the bricks are the system. The system is greater than the goal. Focusing on your habits is more important than worrying about your outcomes. Of course, there’s nothing necessarily impressive about laying a brick. It’s not a fantastic amount of work. It’s not a grand feat of strength or stamina or intelligence. Nobody is going to applaud you for it.
But laying a brick every day, year after year? That’s how you build an empire."
[Excerpt from James Clear]
I've seen too many people attempt to be "heroes" in their organisations. They seek the recognition, adulation, whatever you call it. But a five-minute fame is short-lived. At the end of the day, it is about whether you and the company can bring home the bacon. That's all that matters.
In a fast moving and digital world that seeks instant gratification, patience and foresight, are two highly underrated attributes amongst the young and inexperienced.