can you value any asset

I recently wrote about value investors, albeit, for different reasons. Let's spare them for now. How about those who are on the other side, those who claim that they can value any asset? 

There are many who talk about valuation skills, and proclaim that they are adept at it. I wonder whether those skills are restricted to talking and writing only. I wonder whether they are able to profit from those skills in the real world investing. There is a reason why I wonder.

Value of a cash-flow generating asset is the present value of all cash flows that can be realized over its life. Anybody can do valuation. It is that simple: you only need to estimate cash flows and a discount rate to bring them to the present value. 

But wait, there is more to it. Practically, no one can estimate accurately how much cash flows an asset is going to generate in future. That is simply a prediction, and humans are not good at it. Furthermore, no one knows which discount rate is the correct one to use. 

It is clear that any valuation that we do is going to be wrong. It is also going to be colored by so many other factors such as bias and emotions. In this context, how can anyone be able to value, and profit from it? To make profits, we need to identify gaps between value and price. If the price does not factor input estimates of the analyst it is virtually impossible to make money out of his valuation. Prices are set by marginal investors who are usually large institutions. Their input estimates are going to be very different from an investor's. If those estimates are not likely to converge, value and price won't either. 

There is a good news though, if we are prepared to adhere to a different mechanism. Why get into assets whose cash flows are difficult to predict? For instance, technology companies, young growing companies, distressed businesses. It is not possible to come out with a realistic estimate of cash flows for these businesses; not even the insiders can do it. So we cannot value them reasonably, except on paper. 

The correct thing to do is to rather ignore these stocks, and move on to those where we can estimate cash flows, albeit with less precision. There are certain businesses where we can do it. For instance, those with stable and consistent cash flows, which have demonstrated high return on capital and operating margins. It is better to pick those businesses for valuation. Estimate cash flows based on past record, and future prospects (which is a lot easier than for unstable businesses), and come out with a value. This value is more likely to be in sync with the fundamentals of that business. 

The irony, however, is that such stocks usually sell at high prices. But then, who says we have to buy them regularly? There would be times when the markets are going to be in a depressed state (due to crises, or other reasons), or the company's stock itself is going to be depressed (due to issues that are likely to be temporary). These will be the moments when we should be picking. Markets will eventually come back, and that stable company's problems will eventually be solved so that the prices will reflect its fundamentals. Look at history, and you will find that such opportunities were there on several occasions. 

Of course, there are other sound approaches to investing, some of which I do use. Nevertheless, I find that waiting for the right occasion to buy is the best one. Rest of the time, we can do a few things: keep buying the index; do whatever we want to do in life to have fun, and watch (from far) markets fluctuating by the minute.