Volatility is opportunity. During my master’s studies at Lund University I found myself discussing the topic of risk with a few finance students. I asked if risk is quantifiable. One answered “yes”. The other said that its philosophical and that there isn’t really a right or wrong answer. If the majority of upcoming finance “professionals” believe that risk is quantifiable, you as an intelligent investor have an edge.
Don’t Clutter Your Mind With Beta and WACC
Financial linguistics can be confusing. The term “Beta” in finance, represents the volatility of a security in relation to the overall market. No need to put the calculation here. Simply, a beta of 1.0 means the stocks volatility is along the general market. Below 1.0 equals less volatile and above 1.0 means that it is more volatile (than the general market). Beta is inserted into the calculation of WACC (Weighted Average Cost of Capital) and used as a discount rate.
Defining Risk
In investing the way I define risk is not knowing what you are doing. Or worse, knowing that you don’t know something, and doing it anyway. Think about it. When buying a company within your circle of competence, with a competitive advantage, able management, and for a great price… Are you really engaging in risky behavior?
If the situation described above happens, do you honestly care what Mr. Market is telling you? Buying something for 5 that’s worth 10, you stand to make a 100% return (implying the fundamentals have not changed). Buy at at 4 and the price goes to 10, you’ve made a 150% return. All things being equal, you should be happy at the opportunity to make 150% over 100%. Seemingly “small” differences in price can have a massive impact on the outcome. Compound interest is magic; those who don’t understand it, pay it. Those who do, earn it.
WACC has volatility built into the calculation, which is why I don’t adhere to it in my own valuations. If you know what you are doing, volatility is opportunity and your friend. “Professional” finance is made unnecessary difficult by design. The industry needs justification for its existence. If people can learn business valuation themselves and stick to a wise philosophy, why would they ever hire a “professional” (who statistically will likely not beat the market)?
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Phil Town – The Compounding River Guide
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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