Downside Price Limit

Water Cooler Investing
#1

Hi All - I realize that when sourcing an investment it’s imperative to understand the downside risk, maybe even more important than the potential upside.

That being said, what are some of the ways you folks arrive at your downside valuation? I am aware of using historic multiples and assessing liquidiation value. However, I’m curious if there are other ways. Maybe assessing liabilities and what it would take to clear them from their books. Or extrapolating a scenario analysis of absolute worst case?

I.E. Berkshire historically trades above price/book of 1.0. Even during the crisis it came close but didn’t fall below 1.0. Based on current valuations I’d assume there’s worst case 50% downside (unless something happens to buffett and people over react). Anyways, I digress.

Thanks for taking the time, I appreciate it.

#2

liquidation value would be your base but properly discounting assets for their liquidation value can be difficult. also, many companies see their equity go to zero in a “liqudiation during recession” scenario so this isn’t too useful.

downside risk and your expected holding period for the investment are tied hand-in-hand. if you hold it forever, you can only assume your downside risk is 100%. if you hold it for 1 year, based on some bearish economic scenarios, you may be able to come up with a reasonable liquidation or near-liquidation value.

this is clearly not a science.

#3

i think cvm was saying he marks down all assets by at least 30% iirc

#4

Thanks for the input, guys. Good things to be mindful of.