I think every company I own is overvalued. I also think every company I own is undervalued. Right now you’re probably thinking I’m crazy (you’re probably right)…but let me explain.

One of the biggest mistakes investors can make is to think they “know” what’s going to happen. The truth is, it’s impossible to know what is going to happen in the future. The best we can do is understand what has happened historically, learn about what traits make companies successful over the long-term, invest in companies we believe have those traits and will continue improving in the future, then keep an eye on them in case things get way off track.

If we do this, I think we can find market-beating companies and compound our wealth in the future. Here at 7investing, we’re doing well so far. The average return across all the companies on our scorecard is +57% compared to the S&P 500 which is up 18% over the same time frame:

So we’re doing well so far, but it’s admittedly been a very short time frame and we intend to measure ourselves over a period of years, not months.

So let’s get back to my contradicting statements:

I think every company I own is overvalued. What I mean by this is that when I buy stock and become part-owner of a company, I am mentally prepared for shares of that company to drop 20% or even 30% at some point. If you look at the price history of any great company, it has most likely dropped 30% or more multiple times throughout its history.

However, I buy companies that I believe are undervalued over the long-term. I have completely given up on trying to own companies that will be higher in the next year. I hope that happens, but there are too many things outside of any management team’s control for me to be confident that any particular company’s stock will be higher in one year. But I think I can identify companies that will increase in value and beat the market over three, five, and 10 years, which will allow compounding to truly do its magic.

When it comes to analyzing individual companies I do take valuation into consideration. However, it’s part of the puzzle for me, not the entire puzzle. If I can find a company in an industry that I believe will be larger and more important in the future, with great management (usually founder-led), great products, reliable revenue, high gross margins, and happy customers, I’m willing to “pay up” for it.

I also think about companies differently depending on their market capitalization in relation to their total addressable market capitalization, annual revenue, and year-over-year revenue growth rate.

For example, if a company is in a market that’s estimated to be $50 billion annually and it has a market capitalization of $2 billion with annual revenue of $100 million growing at 50% year-over-year, I’m willing to buy shares at a 20 price-to-sales multiple. However, if a company is in the same $50 billion industry, with a market capitalization of $40 billion, annual revenue of $2 billion, growing at 25% year-over-year, I’d be much less likely to own shares at the same  20 price to sales multiple (especially if I can own the first company).

This is a very simplified example, but the point I want to highlight is that valuation is one piece of a much larger pie when it comes to an investment thesis for me and no matter how confident I am that a company’s stock price will be higher in 3 to 5 years, I fully accept that I can be wrong and I’m always mentally prepared for a 30% drawdown.

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