 Good day fellow investors! Today we're going to talk about stock market valuation. In a recent video about Facebook I made a simple model for analyzing Facebook stock and giving it a value and there are very complex models as we will analyze from Professor de Moderne. So the topics for today are stock market valuation and input parameters, complex or common sense, stock valuation formulas, methods of stock valuation, equity risk premium and how to do stock valuation properly to get good investing returns, not academic titles of grades. To quote Warren Buffett, there is so much that's false and nutty in modern investing practice and modern investment banking that if you just reduce the nonsense, that's a goal you should reasonably hope for, just reducing the nonsense. So what is stock valuation? For example, I recently analyzed Facebook stock and my earnings model looks like this. The parameters used are the growth rate, the discount rate, that is my required return rate, not something the market tells me to use, a price to earnings ratio of 10 for the terminal value, which all lead to one present value that I compare to the stock. You can see more about that in the Facebook video. All other factors are qualitative and not quantitative, where I have to estimate their future growth based on their management, based on their intentions, based on their short-term, long-term objectives, monetization, whatever. And I don't believe anyone can put those into numbers, all those qualitative factors. It's funny to compare my model with Professor's Damoderans model from the Stern School of Business at the New York University. This is 50% of the first Excel sheet of Professor Damoderans page. There are inputs, inputs, inputs discussions and then we come to some very important inputs that consider market numbers, that is the risk-free rate and the initial cost of capital. So all normal things and then something you use from the market where the market tells you what is the real value. We'll discuss later a bit more about the initial cost of capital, but let's quote Munger. Some of the worst business decisions I've seen came with detailed analysis. The higher math was false precision. They do that in business schools because they've got to do something. So we can listen to Munger or Academics. Stock valuation formulas can be simple or complex. Let's go to the initial cost of capital. If you don't know what your firm's cost of capital is, you can compute it in a sheet like the following from Professor Damoderan of course. This shows you more in detail what is required. So you have unlevered beta or beta, risk-free rate, equity-risk premium used in the cost of equity. So all things risk-free rate from the market, equity-risk premium depending where, what's the market you analyze, depending what the risk-free on what market etc etc. So a lot of complexities, a lot of things that really don't have so much in relation to the business you might be analyzing. So you're basing your investment decision on the risk-free rate okay, but then also on the beta-coefficient past equity premiums and here is where academics and practitioners strongly disagree. To quote Munger again using a stock's volatility as a measure of risk is nuts. So on the methods of stock valuation I always like to use a simple example of Luigi who has a restaurant in Venice. Does he care about the risk-free rate? Does he care about the equity premium? Does he care about the volatility of the prices of his restaurant? No, he just cares about how many tourists will come there, how to improve his service, how to grow. It's his family restaurant, he does not care about selling, he looks at how to get better waiters for a little bit less money and how to improve his margin so that the cash he takes home at the end of the year is bigger. That's common sense business. So he is smart and I think Luigi guy like that who developed a great restaurant in Venice who is full from lunch till dinner all time that's a great business and that's a great business person that's something you want to invest in. On the other hand you have academics who would tell Luigi to sell the restaurant 20 years ago then invest it in somewhere else then lose money and that etc etc. So I prefer the common sense business attitude and that is exactly what has helped me extremely well in the past in place of academics numbers complex maths that all looks very nice all make you look very very smart even my phd title makes me look smart but that's not from where the value of my investing comes I hope so. So to quote Munger in the real world you uncover an opportunity and then you compare other opportunities with that and you only invest in the most attractive opportunities that's your opportunity cost that's what you learn in freshman economics the game hasn't changed at all that's why modern portfolio theory is so asinine so you compare different investments and you buy the best investments if the risk premium equity risk premium is higher the risk rate is higher somewhere else but the business is better and it's better than the other business with a lower return for the long term you buy that one some businesses are not related to the government risk to whatever but are somewhere and that's why they are cheaper russian businesses are much cheaper than us businesses on an average so that's something you have to see how and then fit it in a portfolio but using common sense so to finish with the cost of capital a lot of people 90 90 percent of people invest like academics because because 99 percent of people go to schools pay I don't know a quarter of a million for that I was cool education get a job where all their colleagues do the same analysis think the same way and then you are forced to think the same way if you think differently and let's say you outperform underperform the market in a year you're fired it's over so it's very few are those who stay independent there is Buffett there is Claremont there is Dalio and that's it so very few and then a few little smaller players but that's it and if they get into trouble like we have seen Ackman get into trouble lately they lose a lot of their money they invested funds because everybody is chasing everybody else like in herd mentality check the Ackman video for more about that Munger I've never heard an intelligent discussion on cost of capital also on the beta coefficient Facebook stock recently dropped what was it 10% from two something to 170 if you put it in a model the beta got bigger because the volatility is bigger and thus the Facebook stock is riskier however I think buying Facebook at 218 what which was the top is much riskier than buying Facebook and 170 if it drops to 120 then it's even less risk to buy Facebook because risk is a function of price not volatility so that's a big difference between academics and practitioners on the equity risk premium according to academics risk is the standard deviation of a securities price over a number of periods again beta coefficient standard deviation however others say things differently risk is not knowing what you're doing Buffett risk is looking for what you don't know Dalio risk is calculating what is the max permanent capital loss possible Claremont risk is not short term volatility Munger so on stock market valuation as would again Munger say we don't give a damn about lumpy results everyone else is trying to please Wall Street lumpy meaning standard deviation and volatility this is not a small advantage so lumpy results yes big advantage and then long term the risk free rate the equity premium the beta coefficient will change in the long term and if you can see how those things change in the long term that's your second advantage how to destroy the market over the long term yes I said it destroy the market so how to do proper stock valuation the key things to watch our price earnings ratios long term k-pracials earnings growth fundamentals book value the quality of the business have your own discount rate if you must have a discount rate simply use what is your required rate of return for comparisons comparing compare investments and invest in the best handful the more investments you compare compare compare the better investments you will find because there are great investments out there things can go wrong think what can go wrong and keep it simple and then we come to the conclusion academics cannot beat the market because they are the market everybody uses the same formula everybody chasing the same things and then everybody has the same result minus the fees and they don't beat the market all the guys that we mentioned monger klarman delio and buffett have been beating the market for 28 40 60 50 50 something years soros has destroyed the market and all the a lot of those players really beaten the market by just doing applying value investing sound principles mostly common sense principles to investing so okay use those formulas use everything that you have learned at school but first apply common sense and reduce the nonsense I have a phd so I can say these things I'm a practitioner I'm really getting further further away from academics I started my phd I knew what I wanted to prove I just had to prove it in an academic way did that the beta coefficient on my stock market explained 5% of stock market changes stock months price changes fundamentals explained 46% over a three-year period so fundamentals have again destroyed the beta coefficient and 5% explanations is what got them the Nobel prizes but that's a different story so if you want more research stock market research with common sense please check my stock market platform that's all that I do research research research research compare compare find the best handful of investments for long-term investing success with common sense and reducing the nonsense I'll finish with monger I have a name for people who went to the extreme efficient market theory which is bonkers it was an intellectual consistent theory that enabled them to do pretty mathematics so I understand its seductiveness to people with large mathematical gifts it just had a difficulty in that the fundamental assumption did not tie properly to reality thank you for watching looking forward to your comments I know the academics are going to dislike the video if you are a practitioner like the video and I'll see you in the next video