From Underwear Commutes to NBA Draft Busts

What’s up, everybody? Tom here, and today I want to talk about one of my biggest fascinations, stock valuation.

Yeah, I know, you might think, “Tom, that’s nerd stuff.” And hey, it is a bit nerdy, but trust me, you don’t want to throw your cash into random stuff without an idea of what it’s actually worth. 

That’s how you get stuck with worthless coins, worthless stocks, or worse, worthless NFTs with cartoon animals.

Valuations Are Simple (But Most Investors Screw It Up)

Now, let’s set the record straight. The fundamentals of valuation? Are actually simple. Think of the DCF process:

• We look at a company’s future cash flows.
• We estimate the future growth potential.
• We factor in the risk through the discount rate.
• Then we discount those future cashflows back to the present.

That’s it. There’s no rocket science.

There’s no special handshake or alchemy. It’s basically, “Hey, how much money will this business generate in the future? And how risky is it?

Nice and easy.

But somehow the typical investor consistently earns much less than reported market benchmarks like the SP 500. Over a 20 year horizon, the average equity investor’s annualized return lags the SP 500 by several percentage points.

In some years, when the SP 500 has double digit gains, the average investor may earn only mid single digits or worse.

So why most investors get this wrong?

1 word: spreadsheets.

These mother lovers out there on X and YouTube show you these INSANELY complex, labyrinth spreadsheets with macros on macros and data on data.

Slap enough Greek letters, diagrams, and random intangible lines, you get immediate credibility. The problem is complicated and elaborate doesn't mean it's any good, in fact it may be quite the opposite.

Look up a 2015 paper called “On the Reception and Detection of Pseudo-Profound Bullshit” by Pennycook, Cheyne, Barr, Koehler, and Fugelsang.

The study examined how people rate random, grandiose sounding statements, like “Wholeness quiets infinite phenomena” as if they are deeply meaningful. The study found that elaborate sounding randomness can be mistaken for profound wisdom. People who scored lower on analytical thinking measures were more likely to find these random trash to be more significant or deeply profound.

In other words: the more elaborate the spreadsheet, the higher the chance that someone, especially if they’re not trained to fully understand it—will believe the “made up logic.” This insight explains why so many investors sometimes rate random stocks so high using on "objective" valuation tool like a DCF.

Ultimately, healthy skepticism of your own valuations, a habit of asking yourself follow up questions, and an awareness of our own biases and tendencies are the best defenses against being convinced by elaborate spreadsheets, when it comes to our stock valuation process.

Getting Comfortable with Chaos and Uncertainty

Valuations are more like a vision board for the future. “Here’s what I expect to earn. Here’s how big my profit margin might be. Here’s how risky all that is.”

Instead of merely recording the past, valuations lay out what management or investors believe the company can realistically achieve, how much revenue they’ll generate, how profitable those earnings might be, and what sorts of risks or hurdles stand in the way.

Much like mapping out lofty goals on a poster, a valuation paints a picture of next year’s growth trajectory, margin expansion possibilities, and potential market headwinds, all distilled into a single figure that signals how much the business could be worth if those forecasts come true.

Yet, precisely because valuations project into an uncertain future, they’re far from guaranteed.

Just like NBA prospects out of college, who often come with lofty “valuations” that are more like vision boards than guarantees of success. Sam Bowie, who famously was drafted before Michael Jordan in 1984, never lived up to the immense hype.

Then there are names like Greg Oden and Anthony Bennett, each touted as can’t miss talents but ultimately overshadowed by injuries, inconsistencies, or tougher than expected competition.

Their stories remind us that bold forecasts about potential can go south fast when reality sets in.

Going back to stock valuations, even the most promising roadmap can unravel if market conditions shift, product launches flop, or competitors move faster. After all, a valuation is not an accounting statement, it doesn’t simply log what’s already happened in tidy rows and columns.

Instead, it’s a best guess that’s subject to change as soon as reality deviates from those initial assumptions. Investors can find themselves in trouble when they forget that these projections are rooted in possibilities rather than certainties, leaving them vulnerable to miscalculations, sudden market downturns, and the inherent unpredictability of any ambitious business venture.

Okay, we get it Tom, but how can we minimize the risk of getting it wrong? Luckily for you, if you just get comfortable with uncertainty and randomness, you will be doing better than half the “professionals” on X and YouTube.

In any situation on social media, with ANY stock, you have the two camps:

The Numbers Sticklers: They love Excel, betas, discount rates. They own T-shirts that say “I Heart Spreadsheets.”

The Story People: They could sell you a vision of the future that’d make Elon Musk blush. No firm numbers, but oh man, do they have a narrative.

These two camps basically speak past each other. Mostly, they hate each other.

But guess what? If you wanna be good at this game, you need a foot in both camps. A good story is worthless without a financial model.

On the other hand, a pile of numbers in a spreadsheet, is worthless if you don’t have a clue what drives them.

DCF Is Just a Tool: Does Your Car Decide Where You Drive?

So, first of all, despite the current market insanity, I want you to understand that cash flows do matter, a lot. Ignoring cash flows when you valuing a company is like ignoring gravity. You can get away with it for a while, but eventually, you will have to come down.

Right now, markets are going bananas over big narratives, but I don’t care how fancy your story is; if the cash ain’t coming, it’s all smoke.

A good valuation is basically a roadmap of “Here’s what we expect to make, here’s how risky it is,” and guess what, if those expectations are a fantasy, you’re in for a crash. Sure, it’s all a bit of a guessing game (the future’s never certain), but that’s exactly why cash flow matters so much.

If there’s no real money behind that shiny pitch deck, watch out when the music stops.

But hey, I totally get why traders laugh at this while they’re raking in profits, flipping stocks in a momentum driven market that seems to defy all logic. They’re riding the wave, not caring if the underlying business is bleeding money, because their game is short term flips, not long term fundamentals.

So yes, if you’re a trader, you might roll your eyes at talk of free cash flow and discounted returns, after all, you’re focused on quick moves and not worried about when the bubble might pop. But for investors with any kind of horizon beyond next quarter, ignoring cash flow is asking for trouble.

“So Tom, does it mean that if a company has negative cash flows. Should I run away?”

That depends. Negative cash flows forever = worthless.

Negative now because they’re building for a huge future? Not necessarily worthless. Growth companies need to invest early.

Just make sure you don’t get scammed by the notion they’ll magically become profitable.

There's a Luck Factor In Everything (Even in Investing)

Let me tell you a true story.

Jake and Rory had been roommates since college, and their personalities couldn’t be more different. Jake was all about color coded calendars, meditation apps, and a strict 10 p.m. bedtime, he believed that a life of careful planning was the key to success.

Rory, on the other hand, was the poster child for spontaneity. He thrived on late night karaoke, half priced wings, and never met a snooze button he didn’t like.

Despite their clashing lifestyles, both had incredibly important meetings on the same morning, so tensions were high in their cramped apartment leading up to the big day.

Jake laid out tomorrow’s outfit the night before, dress shirt, tie, and socks neatly draped over a chair, while quizzing himself on potential interview questions.

Rory was out at a bar slurping neon cocktails until 2 a.m., promising, as always, that he’d make it home “soon.” In the shared living room, Jake tried to tune out the noise of Rory’s triumphant return, complete with the clatter of dropped keys and a pizza box hitting the floor.

“We’ve got this!” Rory shouted through the door at 3 a.m. Jake, already half asleep, just rolled his eyes and whispered, “Sure we do,” before nestling into his perfectly fluffed pillow.

Morning arrived, and Jake bolted out of bed at dawn, triple checked his meticulously packed briefcase, and trotted confidently to the station…only to hop onto the wrong train going in the complete opposite direction.

Rory, on the other hand, woke up mere minutes before his train left, realized he had no time for pants, yanked on a jacket over his boxers, and tore out of the apartment like a cartoon character. He sprinted down the street, briefcase in one hand, shoes in the other, slammed into the station just as the doors were closing, and miraculously tumbled aboard the right train.

Jake, now 20 miles away on the wrong line, could only stare at his phone in disbelief while Rory texted: “Dude, made it. Still in my underwear, but I’m on the right track!”

Let’s be real: there’s a ton of luck in investing.

You can be the biggest bozo in the world and pick Palantir right before it soared... and next thing you know, you’re on YouTube calling yourself a financial genius. :)

Meanwhile, some poor schmuck does thorough analysis and invests in a perfect little value stock… and it sinks anyway.

Luck is part of life, and investing is no exception.

If you actually want to learn valuation, you can’t do it by reading 50 textbooks or watching 20 YouTube videos (well, except mine, obviously). You must pick a company and just do it. You’ll be wrong at first. Maybe your margin assumptions for Tesla are messed up, or your discount rate is off.

But you get better by messing around and iterating.

Humans don't learn by listening, we learn by doing.

The 5 Steps To Get Good at Valuations

There’s no secret sauce behind valuations.

It’s a lonely journey, its basically you, your assumptions, your spreadsheet, and hopefully, a decent story about future prospects.

• Step 1: Pick a company you understand more about compared to others.
• Step 2: Gather data about the industry, the competition, the business and the product.
• Step 3: Understand The TRUE Story, not the hope or dreams.
• Step 4: Convert it into numbers: revenue, margins, growth and risk.
• Step 5: Update as you get new info about the company.

So let’s summarize:

• Valuation is about projecting future cash flows and discounting for risk.
• Numbers + Narrative = the holy grail. Don’t be all one or the other.
• Uncertainty is always there. You can’t run from it, so incorporate it.
• Luck matters more than we like to admit. But skill eventually should pay off, assuming you live long enough....

So, thanks for hanging out with me for this journey into the wild world of valuations. Hope you enjoyed the jokes and the random NBA references, but more importantly, I hope you can use some of this next time you see a flashy quantum stock or your buddy’s bragging about the next big crypto project.

Until next time—Tom Nash, signing off.