Valuation discipline
The price you pay sets the return you get. A good business bought at a bad price is a bad investment.
There is a sentence worth memorising: a good company and a good investment are not the same thing. The difference between them is entirely the price.
Why price sets return
The cash a business will generate is whatever it is, independent of what you paid. Paying more for the same future cash lowers your return by definition. Nothing about the company's quality changes that arithmetic.
If an asset produces a fixed stream of value, then the return is that stream divided by the price. Raise the price and the return falls. The only way price can rise without lowering future returns is if expectations of the stream rose too.
How expensive prices get justified
Rarely by someone arguing that overpaying is fine. Usually by an argument that the future is different — that growth will be faster or last longer than history suggests. Those arguments are sometimes correct, which is what makes them dangerous.
- “It is expensive for a reason.” Often true, and still compatible with a poor return from here.
- “The old multiples do not apply.” Occasionally true. Also said near every peak.
- “You cannot time the market.” True, and not an argument that price is irrelevant.
The useful discipline
Rather than deciding what something is worth, work out what the current price is assuming. Take the price, and solve for the growth rate that would justify it — then judge whether that rate is plausible. That question has a much better answer rate than “what is fair value?”
Valuation discipline is not a valuation technique. It is the willingness to decline — to hold cash, miss a rally, and look wrong for an extended period. That is the part almost nobody finds difficult in theory.