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Company valuations: Why first principles matter most

Posted on 14/05/202114/05/2021 by Keith McLachlan

‘The more variables going into a valuation, the more chance there is that that the outcome is actually rubbish’: Keith McLachlan, Integral Asset Management.

I sometimes write better than I speak. Especially at 6am.. For the last answer of this interview, the key point I was trying to make is the following:

All successful businesses take inputs and generate outputs that are more valuable than these inputs. The difference between the inputs and outputs is what we call “profit”. Typically we will quantify this in monetary terms, but that is just a scoreboard. More importantly, behind the scoreboard, these businesses are (efficiently) generating goods &/or services that generate utility for their users. You need to understand this utility–how it is generated, why it is consumed, & what substitutes for it may exist–in order to break a business down to its most basics (its so-called First Principles) and then use these to build a valuation that is based on reality. This approach aims to arrive at the least number of key variables that an investor can analyse, track & potentially make an investment decision based on, with regards to an equity investment.

Originally interview appearing here.

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