We often write about valuation because we believe it is one of the most misunderstood aspects of investing in common stocks. This causes many people to hold what we consider to be unjustified biases that are based primarily on price action. For example, the concept of the lost decade, which many almost gleefully point to as evidence validating that stocks are poor investments, fail to recognize that the true culprit was overvaluation during the appropriately labeled “irrational exuberance” days.
However, one of the most misunderstood aspects of overvaluation is how wide ranging and relative it is. To clarify, one company can technically be labeled overvalued, but due to other important factors, still be a good investment or even an above-average investment. It all comes down to the degree of overvaluation the market is applying, relative to the potential long-term growth the business is capable of achieving.