Thought exercise for anyone aping into random coins. If you can answer these questions well you can trade without emotion and I expect you’ll do better than most at the end of this cycle. Think long and hard about these questions and come up with an answer that resonates with you and that you can adhere to.
If I had a company that we could precisely predict the growth rate, the revenue, the share schedule, and any stockholder benefits of such as share buybacks and dividends, if you could remove all uncertainty about the trajectory of the company, what should it be worth right now? What do you say is the “fair value” of the stock?
For some numbers, let’s say our company is generated $10M a year in revenue after all expenses and this will go up by 10% every 12 months. If it’s like many stocks and there are no dividends or buybacks what should the market cap of the stock for this company be? If this company used 10% of its excess revenue for stock buybacks how does that change your valuation? What if that money was paid as dividends to holders instead? Is that different and why? How do you factor in if shares are being regularly issued? How does your valuation now change if we changed the 10% revenue growth to 20%? If there were 10 such companies with different parameters but without any uncertainty of their future, how would you distribute your funds? Would you always move 100% of your stack to 1 company or would you still spread the money around?
Now, add in a market. Other people with different answers to your questions above are rationally shifting around their funds according to their policy. Do you change your answer to how you invest based on what everyone else is doing and how? Again, assuming the trajectory of the company is perfectly predictable but the market behavior is not. How suboptimal does your policy have to be before you adjust it? Do you buy the stock that is the furthest below your answer to its “fair value” even as the rest of the market is selling it? How much do you buy and when? If it’s down 50% from when you first bought are you selling or buying more? Are you willing to hold for 2 years while you are down 90%?
Now, add in some uncertainty on the growth. The revenue growth will be 10% with a 1% standard deviation. How does this affect your answers to the above?