A Word about Discounts and Expected Values

I left my comments on Whopper Investments. Any discussion about this topic has always caught my attention. I still grapple with the ideas put forth by different people but have come around to my own comfortable conclusions.

Someone posted a comment that basically said (and I’m changing the words a bit): :I disagree. I use discount rates to adjust for risk. If you were to offer me the choice of a guaranteed $1 or a 50% chance of $2 vs. a 50% of zero, I would take the guarantee every time. I need to use discount rates to adjust for that.”

This is faulty thinking. Remember, this is a stock market offering multiple choices for investment. If something with an expected value of $1 coming from a 50% chance of zero and..

My comments in response:

Owen says:March 18, 2013 at 4:13 pmIn the context of generating profits for the risks taken, we are entering murky waters This is a good discussion on risk versus discounts but it is similar to how investor categorize their investment strategy as growth or value investing, they are joined at the hips. With the matter of expected values and discounts we have to consider timing as a key element. You have to tie in the risk/reward analysis and geo-expected(annualized) returns to make an investment worth the trip. Is the invest worth the risk and time given our “current” rational expectations? Discounting should be used more for assessing versus risk-adjusting expected returns.In terms of Kelly, you have a strategy that avoids gambler’s ruin should worse cases materialize, given a large sample space of bets.Cash flow projection another story: Amazon’s cash flow year end 2000 vs Washington Post cash flow 2000. It is better to be opportunistic in your approach than cash flow sensitive in projections.Good investing,Owen.