Investment Outlook: Reading stock prices for better returns. 2021 – Revised and updated. Michael J. Mauboussin and Alfred Rappaport. Columbia Business School edition.
Expectations Investing: Read stock prices for better returns represents an important resource for practitioners seeking an insightful alternative approach to identifying price-value discrepancies. This volume is a revised and updated version of the 2001 book written by Michael J. Mauboussin, Head of Consilient Research at Counterpoint Global, Morgan Stanley Investment Management and Assistant Professor of Finance at Columbia Business School, and Alfred Rappaport, Leonard Spacek Professor Emeritus. at Northwestern University’s Kellogg School of Management.
The current version reflects the many changes in the accounting and business landscape since the original was published. For example, the new edition shows a greater focus on disruption and the value it creates and destroys, as well as a greater focus on user/subscriber platforms, which are exploitable for profit and offer optionality. Other changes in the investment world addressed in this update include a shift from active to passive investing, the rise of intangible investments, and a redirection of capital from public to private equity.
The authors argue that investors should start with a company’s stock price and ask what it implies for future financial results. They provide strategic and financial analysis guidance to help investors assess the likelihood of revisions to these expectations. His framework follows value creation from the triggers that shape a company’s performance to the impact on value drivers, allowing an investment practitioner to determine whether to buy or sell a stock. Investors who absorb these lessons will be able to evaluate the stocks of companies in any sector/geography more effectively than using standard approaches. In addition, corporate managers can use the book’s insights to create, modify, and communicate their company’s strategy in the context of shareholder expectations.
Chapters 5, 6, and 7 describe the three steps of the expectation inversion process. These chapters form the core of the book and are all you need to analyze the stocks of most companies.
Chapter 5 describes the first step, which is to estimate the market expectations that justify a company’s stock price. Expectations investing allows you to take advantage of the discounted cash flow (DCF) model without needing to forecast long-term cash flows. You must clearly understand where expectations stand today before you can consider the likelihood and magnitude of revisions to expectations.
Chapter 6 integrates the tools of previous chapters to identify potential revisions to current expectations, which form the basis for investment opportunities. Four building blocks form the foundation for identifying expectations opportunities: historical performance and PIEs (price-implied expectations) provide the data, while competitive strategy analysis and expectations infrastructure provide the analytical tools .
Chapter 7 sets standards for decisions to buy, sell, or hold shares—the final step in the process. The magnitude of the excess return depends on how much of a discount a stock trades relative to its expected value and how long it takes the market to revise its expectations. The greater the discount to the share price and the sooner the market revises its expectations, the greater the return.
Moving beyond DCF valuation to look at real options, Chapter 8 is important reading for analysts and investors. It provides both a tool that can be used to improve the determination of intrinsic value and practical ways to use it. Mauboussin and Rappaport believe that the DCF model is relevant for valuing startups, as long as you supplement it with real options analysis. Because the DCF model can underestimate the value of flexibility, it can lead to a misreading of the expectations implicit in pricing for a business with a large amount of uncertainty. Real options, however, capture the potential value of uncertain future opportunities. The example of Shopify, Inc. of this section is a must-read if you’re pondering how best to value certain startups and technology companies.
In summary, this revised and updated edition provides an insightful framework for identifying gaps between price and value while reflecting the many changes in accounting and business over the past 20 years. The book’s insights and principles will help professionals, both investors and business managers, operate more effectively in light of shareholder expectations.
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All posts are the opinion of the author. Therefore, they should not be construed as investment advice, nor do the views expressed necessarily reflect the views of the CFA Institute or the author’s employer.
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