Tren Griffin @trengriffin I work for Microsoft. Previously I was a partner at Eagle River, a private equity firm established by Craig McCaw. I am on the board of directors of Kymeta. Oct. 26, 2019 4 min read

1/ Michael Mauboussin: “A beautiful thing about expectations investing is it actually reverse engineers the process. … implied from the market price [are] the expectations for a business.” 

2/ “One thing we know for sure is the price. You then basically are asking a simple question: what has to happen for this price to make sense? Can I do a good job, or a reasonable job, of trying to understand the consensus expectations that are built into this price?"

3/ "Sales growth rates, operating profit margins, capital intensity, and understanding what has to happen for that price to make sense. You’re making an over-under judgment rather than saying, ‘I have a laser precision as to what I think the thing is worth.’” To be continued...

4/ "An investor’s primary task is to determine whether the expectations for future financial performance, as implied by the stock price, are too optimistic or pessimistic relative to how the company is likely to perform."

Michael Mauboussin 

5/ "The key to achieving superior investment results is to begin by estimating the performance expectations embedded in the current stock price and then to correctly anticipate revisions in those expectations." Rappaport & Mauboussin 

6/ Reverse DCF: Start with the current market stock price, determine the growth rates required to justify that price and compare the implied growth against a historical distribution of comparable business growth rates over time to determine the probability of it being achieved.

7/ There will be occasionally be times when an investor who is patient, observant and acting within their circle of competence can find a mispriced bet. When significant mispricing can be identified, an investment opportunity has been identified.

8/ "If you stop to think about it, a pari-mutuel system at the racetrack is a market. Everybody goes there and bets and the odds change based on what’s bet. That’s what happens in the stock market.” Charlie Munger 

9/ "A growth manager buys a stock, she's betting the market isn't fully capturing the company's growth prospects. A value manager bets the market is underestimating the company's value. In both cases, they believe the market's expectations are incorrect." 

10/ “If you’re earning excess returns, growth is a wonderful thing. The faster you grow, the more wealth you will create. If you’re earning below your cost to capital, growth is bad, because the faster you grow, the more wealth you’ll destroy.” 

11/ “The key to generating excess returns is the ability to distinguish between price and value—two very distinct concepts. The most basic question you must always answer: what’s priced in?” Maiboussin 

12/ “Everyone knows that regression toward the mean is important, especially if you’re a value investor, and the ‘Base Rate Book’ tells you how to operationalize it.” 

13/ "An executive needs to understand what markets expect, and exceeding those expectations will make your stock go up. The market may think you’re going to create a lot of value, but if you don’t create as much value as the market thinks, your stock is going to underperform."

14/ "What you’re trying to do is buy low expectations and sell high expectations. Value investing to me is just buying low expectations. In the Fama-French model, value is statistically cheap stuff, which is a proxy for low expectations, but sometimes it’s just bad stuff."

15/ "One of the biggest mistakes in investing is people fail to distinguish between what’s priced in and what’s going to happen fundamentally. These are two different mindsets. It’s the difference between the odds at the horse race and how fast you expect the horse to run." MM

16/ "Think forwards and backwards — invert, always invert. Many hard problems are best solved when they are addressed backward. The way complex adaptive systems work is that problems are easier to solve, if you turn them around in reverse." Charlie Munger 

17/ "Use competitive strategy analysis to help anticipate revisions in expectations. The surest way for investors to anticipate expectations revisions is to foresee shifts in a company’s competitive dynamics." Michael Mauboussin 

18/ "Competitive strategy and valuation should be joined at the hip. Which is to say, the litmus test of a good strategy is that it creates value, and that you can’t really do a thoughtful valuation without understanding the economics of a business and the industry." MM

19/ "In business school we teach strategy and finance separately. The strategy professors say, 'well, you want your strategy to create value' but they don’t really explain the financials. Finance professors say 'it’s good to have a competitive advantage,” but don’t quantify it.'"

20/ "Expectations Investing was published September 10, 2001, the day before a national tragedy and during a bear market. While timing on the release wasn't ideal, it was an awesome project. Just being able to work with someone who’s your mentor..." MM 

21/ Do you want to learn about Expectations Investing/reverse DCF in a podcast format? You can listen starting at 1:38 in this podcast: 

"The approach offers a specific process to calculate potential
outcomes based on various revisions in expectations."

22/ The next tweetstorm in this series will be about "competitive advantage period" (CAP) and how it impacts terminal value in a discounted cash flow analysis. That won't be a thrill a minute, but as Charlie Munger once said: "If it's trite, it's right." 

24/ Assume you were asked in 1999 to invest in the Google Series A at a $75 million pre-money valuation. The three step Expectations Investing process would have been:

1. Estimate price-implied expectations:

2. Identify any expectation opportunity; and

3. Make the decision.

You can follow @trengriffin.


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