The 3 steps of Expectations Investing by Michael Mauboussin | Summary and Q&A

TL;DR

Expectations investing involves reverse engineering stock prices, conducting historical and strategic analysis, and making buy, sell, or hold decisions based on valuation models.

Key Insights

• ☠️ Expectations investing involves reverse engineering stock prices to understand the drivers of value, such as sales growth rate, margins, and capital intensity.
• ⚾ Historical and strategic analysis helps determine whether a company will meet or exceed expectations, and the valuation should be based on the company's expected performance.
• ❓ Multiples should not be mistaken for valuation; they are shorthand representations of the valuation process and require understanding of the economic implications.
• 🔠 Growth should be qualified based on the return on capital and cost of capital spread to determine if it adds value or not.
• 💐 Explicit valuation models, like discounted cash flow models, provide a clear understanding of future value creation and investment needs.
• 🥺 Using multiples without understanding the underlying economic assumptions can lead to misleading valuations and investment decisions.
• 🤔 Expectations investing emphasizes probabilistic thinking, considering different scenarios and assigning probabilities to potential outcomes.

Transcript

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Questions & Answers

Q: What are the three steps of expectations investing?

The three steps include reverse engineering stock prices using a discounted cash flow model, analyzing historical and strategic factors, and making decisions based on the valuation model.

Q: How should one use valuation multiples in expectations investing?

Valuation multiples, such as PE and EV/EBITDA, should be used as shorthands for the valuation process, but one must understand the economic assumptions underlying those multiples for them to make sense.

Q: What is the importance of historical and strategic analysis in expectations investing?

Historical and strategic analysis helps assess whether a company will meet, exceed, or fall short of expectations by evaluating its past performance and future strategies.

Q: Why is growth not always value-creating in expectations investing?

Growth only adds value when a company earns above the cost of capital. Therefore, it is important to consider the return on capital and cost of capital spread before qualifying growth as value-creating.

Summary & Key Takeaways

• Expectations investing consists of three steps: reverse engineering stock prices using a discounted cash flow model, analyzing historical and strategic factors to evaluate a company's performance, and making decisions based on the valuation model.

• Multiples, such as PE and EV/EBITDA, should not be confused with valuation, but considered as shorthands for the valuation process, relying on economic assumptions.

• Growth alone does not guarantee value creation; growth only adds value when a company earns above the cost of capital.