Written at Tencent 350, discussing the valuation gap caused by cognitive differences.

The previous article was 'Written at Tencent 390'. Many people said that Tencent couldn't buy back shares before releasing its interim report, and they speculated that the stock might fall, so they didn't dare to buy.

Actually, I really want to ask: Is it because Tencent didn't buy back shares that caused the stock price to fall, or is it because the market expected Tencent not to buy back shares and might fall, so they didn't buy, which led to the decline? This seems like a chicken-and-egg problem.

But no matter what the reason is, which one is the starting point? If we agree that buying stocks is buying a company, and buying stocks means holding a part of the company, then ultimately, a company's stock price and market value are mainly determined by its long-term operating results—that is, the sustainable profits it generates by consistently creating value for society, which are highly correlated with the company's final market value and stock price.

Based on the idea that buying stocks is buying a company, and buying a company is buying the actual profits distributed to shareholders from its ongoing operations, estimating a company's profits for the next one, three, five, seven, or ten years, and how these profits will provide returns to shareholders, is the most important basis for judging a company's ultimate value.

Although many investment systems only treat fundamentals or a company's profitability as part of the investment framework, a company's performance still has a certain impact in these systems. Therefore, most market participants will still estimate corporate profits.

Investment bank analysts will provide profit guidance, researchers will track companies continuously and write valuation research reports, and individual investors will also look at metrics like PE and PB.

But in reality, because everyone's past experiences are different and their understanding and construction of investment systems vary, the valuations different individuals assign to a company can be vastly different.

Take Tencent as an example. When Tencent rose to 400, we saw research reports and personal opinions in the market giving it higher expectations. Common themes included growth from large models, cloud computing, video advertising, etc.

Of course, when Tencent recently fell to 360, there were analyses about potential changes in Tencent's payment business. I already wrote about my judgment on this matter in previous articles.

When Tencent was at 200 in 2022, the market was flooded with various events—other than the major shareholder's reduction—that later proved nonexistent.

And when people saw at the beginning of 2024 that Tencent might buy back 100 billion this year, along with high revenue and profit expectations for 2024, many institutions raised their expectations for Tencent's returns, which became one of the most important reasons for Tencent's surge from around 300 to 400.

In short, for the same event, the market always has huge cognitive gaps and disagreements initially. But over time, the truth will come out, and those who pay attention will eventually know the real answer. This is the scary part of hindsight—because initial judgments often differ greatly from those made after time has passed.

To prevent hindsight bias, the best way is to record your judgments at the time of impact to avoid convincing yourself that your past judgments were as wise as they seem now.

The main source of cognitive gaps is actually everyone's different experiences and ways of looking at problems. In fact, cognitive gaps exist not just in investing but in all aspects of life. It's just that in investing, cognitive gaps have a larger impact on valuations.

Moreover, beyond the basic information we commonly use—such as how much profit Tencent makes or the profit composition of each business—the deeper logic lies in the underlying principles behind these objective data. For example, what is Tencent's investment share in 'Black Myth: Wukong,' and will it generate cash flow returns?

Going even deeper, there are questions like Tencent's investments in Douyu, Huya, and the cultivation of the 'Black Myth: Wukong' team. Can these be calculated purely in terms of numerical profit returns? If these businesses don't directly generate profits, do they still have synergistic value for Tencent?

Similarly, if Tencent Video isn't profitable, does it still have synergistic value for Tencent's overall business? Is it an indispensable part of Tencent's ecosystem, meaning it creates value even if it can't be directly measured in profits? What about Tencent Music? What about China Literature?

All of the above refers to the business logic behind basic numbers, especially profit and performance data. Digging deeper, you can uncover many underlying principles. For example, which game engines has Tencent invested in? Has Tencent developed its own engine? What are the differences between Tencent's engine and popular ones on the market? How do these engine investments ultimately benefit Tencent's gaming business? These are all questions that, under specific circumstances, could impact ongoing operating performance and sometimes require research and deep digging.

But what truly affects valuation results, research outcomes, and cognitive gaps, in my opinion, is emotion. If everyone approached research from an objective and rational perspective, with equal talent, it would just come down to time investment.

But in reality, cognitive and valuation gaps mostly arise due to emotions. There are many emotional influencing factors. The most common emotions are optimism caused by rising stock prices and pessimism caused by falling stock prices.

Going even deeper, if someone in a team has a correct but different opinion from the group or leadership, they might not voice it to avoid the risk of personal loss. This is human nature in many team settings.

Even in public settings, like chatting with friends, even if the relationship is good, some people might choose not to speak up if they know others disagree, because speaking up might not only fail to gain approval but could also lead to exclusion.

So, what often seems like individual emotions influenced by rising or falling prices can, on a group level, become inertia or erroneous judgments under the influence of massive group dynamics.

Moreover, if your leaders, colleagues, or even the entire industry agree on a viewpoint, under the influence of groupthink, you might even doubt whether your own judgment is correct—especially when your leader is more experienced and, more importantly, holds greater social authority.

In summary, I believe that when individuals maintain relative independence and can research and think about a problem on their own, the differences come down to personal talent and time investment. With enough time, research results will still be relatively close to reality. Of course, those with better talent, who continuously train this skill and have more experience, will undoubtedly be more efficient.

But what truly affects research results is the individual emotions brought about by price movements and the influence of group decision-making, especially under authority. These can cause personal and group judgments to deviate greatly from a company's objective situation, creating huge cognitive and valuation gaps in the market.

I think this is likely the reason for the formation of 'Mr. Market' and one of the reasons why companies like Tencent can go to 200, then to 400, and even to 700 (the peak in previous years).

Of course, some friends might say this is also related to interest rate hikes, cuts, and changes in Tencent's performance. From a market perspective, supply and demand will definitely affect price changes—less money naturally leads to lower stock prices for a company, and more money leads to higher prices.

But in essence, if the market were entirely objective and rational, money would theoretically flow rationally to companies with lower risk and higher expected returns. For example, Tencent at 200 had these characteristics. But in reality, this isn't the case, because the market has huge cognitive gaps, which is why a company can fall to 200 and also rise to 400 and 700 (the peak in previous years).

$TENCENT(700.HK)

Source: Bosi