Bridging the Gap
From Morningstar comes this ditty:
“There are several tools that Morningstar uses to interpret the fundamentals of a firm in order to bridge the gap between art and science, hopefully paving the way to a nice profit in the process. Two of our favorite bridges that help us arrive at prediction of a company’s intrinsic value and a “consider-buy” price are moat and risk. Briefly, an economic moat is a firm’s ability to utilize its sustainable competitive advantages to outperform rivals and earn returns greater than its cost of capital. The risk of a company, on the other hand, is the strength of the underlying business and the predictability and certainty of its future cash flows. Risk is determined by analyzing factors such as cyclicality, leverage, legal issues, and other outside events. In turn, risk ratings affect the size of the margin of safety that we build into our investment recommendations. But not everyone’s opinion, interpretation, or prediction of these metrics is the same. This is where we believe value can be found: by correctly selecting firms with economic moats that are trading at attractive discounts to our fair value estimate, given the margin of safety implied by our risk rating.”
How is the average trader (or frankly the professional) supposed to do all of this and do it right? Why do many of the great traders never think like this?
