The conventional view of how to value companies:
(1) Analyze the company + its financials + future cash flows;
(2) Calculate the correct valuation.
What actually happens:
(1) Observe current market valuation;
(2) Construct theory and model to explain that valuation.
In this way, George Soros’s theory of reflexivity is exactly correct. Fundamentals influence prices which influence fundamentals which influence prices which influence fundamentals… ad infinitum.
At the cyclical top, high prices drive creation of theories to explain infinite future glory; negative investors and analysts get fired. At cyclical bottom, low prices drive creation of theories to explain permanent future misery; positive investors and analysts get fired.
Therefore, a boom in theories of how everything’s a bubble and certain to crash is evidence of a cyclical bottom, not a cyclical top. Therefore, Efficient Market Hypothesis is correct if for “all information” you substitute “all information, theories, noise, and bullsh*t”. Since we are social animals, the challenge of actually standing outside of the herd is brutally hard. Pressure to conform is constant/intense.
Famous paper well worth reading: “The Limits of Arbitrage”
Another famous paper well worth reading: “Noise” by the great Fischer Black
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Let’s talk about Valuing Companies….