During his recent interview with the CFA Society India, Vitaliy Katsenelson explained why investors need to beware of the relative valuation trap. Here’s an excerpt from the interview:
Katsenelson: In this environment I think the strategy that works is kind of value investment strategy. Also you have to be very careful because in the past if you use the relative valuation it worked beautifully. Today, in the sideways markets it’s going to hurt you a lot.
Let me give an example. Let’s say you look at a company it’s trading at 40 times earnings, I’m just making this up, okay and you say well it used to trade at 65 times so therefore it’s cheap.
Well what happens in the valuations, the price turnings you can observe in the future are going to be very different the one you observe during the bull market space.
Therefore, if you do relative valuation analysis it’s going to lead you into what I call relative valuation trap. So you want to be very careful.
So when you buy companies you want to make sure that they are actually undervalued based on their cash flows. So you got to make this kind of modifications.
Also another one is you need to become an active a seller as well. So when a company becomes fully valued you don’t hope that it becomes overvalued, you just sell it.
You can watch the entire discussion here:
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