Does valuation matter?

Charlie Aitken

Aitken Investment Management

We recently compiled a fairly detailed note for investors and subscribers that addresses an evergreen question: how much can an investor safely pay up to own a high-quality, fast-growing business?

Given the valuations currently on offer for high growth businesses - and the prices being offered in M&A transactions - we believe it is a sensible time to try and unpack this thorny issue.

Fundamentally, the main challenge lies in understanding whether the current price quoted by the market already reflects the inherent quality and future growth prospects of a business. If it does, then it logically follows that paying the current price will not lead to superior long-term results, as all the future ‘good news’ is already capitalised in the price quoted today.

The note provides a framework to evaluate embedded expectations in a stock price, by using high-quality and high-flying software company Snowflake (a business and management team we genuinely respect) as an example. This framework is a simplified version of the approach we use when evaluating investment opportunities at AIM.

Our analysis concludes:

  • Starting valuations matter, even when investing in faster-growing opportunities. It is absolutely possible to overpay for a high-quality, high-growth business, and price agnostic investing usually does not end well.
  • Businesses requiring many years of sustained high revenue growth to justify the current valuation carry high risk. In most cases, history suggests that these high long-term growth rates are unlikely to materialise in the vast majority of cases.
  • Balance in portfolio construction is important. Any portfolio might benefit from one or two hyper-growth businesses that can deliver an extremely positive outcome, but to have a portfolio filled only with businesses trading on such extreme valuations does not tend to end well.

Download the full note: What Test Cricket Can Teach Us About Valuation & Long-Term Investing?

We hope you find it interesting. 

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This communication has been prepared by Aitken Investment Management Pty Ltd ABN 63 603 583 768, AFSL 473534. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs. Past returns are not an indicator of future returns. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The product disclosure statement (PDS) for the AIM Global High Conviction Fund, issued by The Trust Company (RE Services) Limited, should be considered before deciding whether to acquire or hold units in the fund. The PDS can be obtained by calling 02 8379 3700 or visiting www.aimfunds.com.au. No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor’s capital.

Charlie Aitken
Aitken Investment Management
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