privatefarmer wrote:The way I think of it is : I want to own companies for 30+ years.
This is a good outline. But there are a lot of minor points of disagreement here.
Let's start with that? Why shouldn't you want to own shares in companies that have the best returns and not own shares in companies that have substandard returns? What does 30 plus years get you? Now if you mean you want to hold a percentage of the USA market, sure that means you want to hold funds. But there is no particular reason you want those funds to want to hold any particular company.
privatefarmer wrote: If the companies I own grow their earnings, the share price will increase at most likely the same rate to keep the P/E anchored at around the historical average (ie 15-20).
That's not quite true. 30 years while not a huge amount of time in the life of a company is long enough to see a noticeable bias. Companies start in industries where the long term return on capital is on average well above the national average. As they invest capital the return on capital within those industries on average frequently declines, competition compresses margins. You should over say a 200 year period expect to see a u-shape where the P/E starts high (because a company is growing things like sales or I/P to use your example below). Then this number lowers as the returns on capital are realized and become unsustainably high. Then start to increase as the industry experiences declining margins and return on reinvested capital falls to well below the national average. A company with growing earnings on average is going to have a substantially higher P/E than one with falling earnings, and they should.
privatefarmer wrote: It all comes down to : what companies will grow their profits the fastest over the next X number of years? Who the hell knows.
Statistically companies in industries whose margins are well below average due to oversupply where demand is increasing. So companies with strong top line growth experiencing bottom line declines. Your typical growth stocks grow their earnings the fastest.
privatefarmer wrote: Just bc a company is classified as "value" or "growth" doesn't tell you anything about the future widgets that they will sell or what their industries will look like over the next 30 years. So buy them all.
Why is "buy them all the answer"? Why not buy who have structural advantages relative to market pricing?
privatefarmer wrote: Or, if you look at price/book, that doesn't consider the "book value" of all the geniuses working at google and facebook, for example. How do you put a price on the intellectual property that they control?
First off that number becomes relevant if you think the companies are likely to be bought. You would want to apply that to unsuccessful and advertising and social media companies. Successful ones you are valuing based on earnings not book. The book is a concern only in that you are going to be valuing their earnings so highly that you know if the company starts faltering the acquisition price will be considerably lower than what you pay today. So you should assign a higher risk premium because the floor is a long way down and move on from there.
The way you estimate the value of I/P for unsuccessful companies is a reasonably discounted fraction of what it costs to acquire the knowledge in the first place, assuming it is worthwhile. This is frequently how you evaluate bio-tech firms since most fail as businesses but are acquired for their research. For research that is promising something like 50% of the investment over the last decade. For research that is very promising you need expertise. For companies in the social media space (Facebook's space), their I/P seems to be mostly worthless, however their customer base has tremendous value. Google has too many sub businesses to do an estimate and they are too complex. Only in a situation where most of them are failing would that number be relevant.
Most companies are not that complex however. They are much much simpler.
privatefarmer wrote: All I know is that I know next to nothing. But I do believe that hedge funds, actively managed funds, and people like Warren Buffett will collectively price every stock better than I could so I might as well buy them all at current prices instead of trying to outsmart those who do this for a living.
The evidence shows that to be false, as I've shown above. They collectively price stocks worse than you could even using simple metrics. They do such a dreadful job on average you can still be only slightly less terrible and win.
privatefarmer wrote: We simply do not know what stocks will grow their earnings the most over the coming decades and that really is the crux of the issue.
First off their are many companies whose earnings are relatively stable or gently falling. A decade is a long time and their earnings may not be as stable as they were 10 years out. But they don't usually go from stable to highly unstable in that short a period of time. Not being able to value Google is not the same as not being able to value most stocks. Google is much more complex than the average company, an almost worst case.
Remember you aren't having to determine the perfect price. You only have to determine if on average the market price is likely too high or too low. You can be wrong 40% of the time and right 60% of the time and still show a huge profit margin for your trouble.
Even if there is no way to know the growth of earnings for most companies with about 7000 major USA stocks if you can know if for 2% that's 140. The next question is whether the market has persistent biases towards assuming that earnings growth is more stable than it is. The answer is yes. That's an exploitable inefficiency regardless of how good you are at solving the complex stock valuation problem.
For many companies it perfect price doesn't matter too much. Pick a company you know something about and try:
https://www.trefis.com/companies
privatefarmer wrote: If we invest for decade we hopefully will see our stocks more than double in price therefore whether you buy a stock at a P/E of 15 vs 25 really isn't as impactful if the stock is worth say 8x what you initially bought it at.
Buying a company for 2x what it is worth vs one that is fairly priced costs you on average 7.1% of your return over a decade or 2.3% over 30 years. It makes a difference even for a long time buy and hold investor. This is not a small issue. Buying a company for 2x what it is worth vs. focusing your buying on ones selling for for 1/2 what it is worth, doubles those numbers. 4.6% is larger than the risk premium for equity over bonds. So if you are making this mistake consistently in your initial buys at the start of 30 years it would wipe out all your profits for buying equity over bonds even over a 30 year holding period. Now cap weighting doesn't force you to always make this mistake but it substantially biases you towards this mistake.
Valuation is not something to be cavalier about. You wouldn't be cavalier about what a 2.3% expense ratio would do to your returns on a mutual fund. Why be cavalier about an equally destructive habit?