In the past few decades, the world’s financial markets have witnessed a multitude of shifts, upheavals, and transformations, yet the core principle of value investing continues to stand the test of time. This investment approach remains a topic of robust debate, with various interpretations and methodologies emerging in the process. At the heart of this discourse lies a critical question: How do we truly assess a company's worth? Some proponents argue that absolute undervaluation as reflected in static financial statements offers a safety margin, while others contend that a deeper focus on a firm’s competitive advantages is necessary to gauge potential long-term value accurately. The task of succinctly appraising a company’s mid-to-long-term prospects becomes the quintessential challenge of the value investment philosophy. In this light, I would like to share some of my reflections on corporate valuation, which may serve as preliminary insights into the complexities at play.

From a purely quantitative standpoint, low valuations do not unequivocally signify that a company’s market value is drastically underestimated. Valuation multiples are influenced by numerous factors, including the prevailing industry dynamics and the nature of the business model. It is common knowledge that industries can be categorized as having either sound or poor business propositions. Some sectors contend with lower barriers to entry, reduced bargaining power, or variable demand preferences which ultimately mute their potential for sustainable high valuations. Additionally, the competitive positioning of a business plays a pivotal role; companies that enjoy competitive advantages can expand their market share, thereby justifying a premium in their valuations. Moreover, the lifecycle stage of a business—whether it is in a growth, mature, or declining phase—affects the assessment of its worth. The prospect of a second growth phase also adds further complexity. Thus, relying solely on low valuation multiples to declare a company as significantly undervalued may expose investors to a considerable risk of misjudgment, as the passage of time often unveils and amplifies operational uncertainties, resulting in phenomena where stocks become increasingly expensive as they decline in price.

Historically, however, it cannot be overlooked that low valuations have served as effective filters for identifying substantial investment opportunities. When stock prices navigate downward—stemming from market apprehensions, anxieties, or panic—they provide a vantage point for discerning investors who recognize that these panic-sold stocks may possess inherent value. It is important to understand that a specific company or industry does not inherently possess a low valuation; entities such as steel and real estate stocks have cycled through periods of both high growth and overvaluation. The valuation thresholds for these industries fluctuate and evolve with the tides of historical context, industry changes, and company transformations. Investors entering the market in different epochs, lacking a macro-level perspective or deep industry insight, might fall prey to the pitfalls of cognitive biases. Assuming that certain sectors or firms are perpetually undervalued can lead to missed opportunities for capitalizing on substantial investment trends. For instance, during the 2016-2017 rebirth of blue-chip stocks in the A-share market, astute investors who recognized the emerging capacity of leading companies to capture increased market share through financial analysis may have successfully navigated this landscape, facilitating a so-called “Davis Double Play”—wherein both earnings and valuations surged instead of blindly adhering to prevailing market discount notions.

Conversely, one cannot ignore the reality that excessive valuations can encapsulate significant risk and volatility, especially when such valuations defy rational justification through objective and thorough analysis. The oft-cited adage “existence implies rationality” or “the market is always correct” falls short in explaining the irrational exuberance that bubbles under conditions of overvaluation. History has repeatedly showcased the irrationalities born from human greed leading to the inception, growth, and eventual bursting of economic bubbles, especially those characterized by exorbitant valuations. For example, the infamous dot-com bubble of the late 1990s and the speculative frenzy surrounding “Internet Plus” stocks in China in 2015 were punctuated by market metrics such as price-to-earnings (P/E), price-to-book (P/B), and price-to-sales (P/S) ratios presenting starkly inflated figures that defied coherent rationale. Speculators, enshrouded in the cloak of “sector valuations,” frequently touted narratives proclaiming “this time is different.” Yet, historical patterns reveal an uncanny similarity across different bubbles; while predicting the timing and trajectory of such downfalls remains elusive, the eventual descent often mirrors a chaotic aftermath.

It is critical to point out that the realm of investment is not constrained solely to absolute low valuations. Throughout history, the most lucrative investment opportunities may not necessarily present themselves at bargain prices. Investors tend to simultaneously grasp the merits of “ten-bagger” or “hundred-bagger” stocks, which frequently exhibit reasonable or even slightly elevated valuations. An unyielding commitment to a dogmatic strategy of hunting for “cigarette butt” investments can obscure one's vision from recognizing these exceptional investment prospects. This tendency to cling to a myopic view could inhibit a broader understanding of the prevailing investment themes that warrant active participation. This notion partially explains why Warren Buffett, having studied under Benjamin Graham, has carved out an illustrious career that far surpasses his mentor, indicating that strict adherence to traditional valuation paradigms may not universally apply.

In conclusion, a nuanced evaluation of valuations undeniably serves as a crucial component in guiding investment judgments and analyses. Nevertheless, it is essential to refrain from viewing these metrics in isolation or through a rigid lens. While it is fundamental to maintain vigilance against market bubbles, it is equally crucial to remain open to seizing opportunities that may emerge unexpectedly. I firmly believe that a disciplined and sustainable investment strategy should focus on identifying high-quality enterprises, acquiring them within an acceptable mid-to-long-term range of valuations, and fostering growth alongside these companies. By steadfastly adhering to the principles of value investing, one stands poised to unlock enduring returns in the long run.