Michael Mauboussin on Expectations Investing: Reading Stock Prices
Expectations Investing: Reading Stock Prices
Short Summary:
Michael Mauboussin, a renowned investor and author, presents his concept of "Expectations Investing," which emphasizes the importance of understanding market expectations and how they drive stock prices. He argues that investors should focus on anticipating revisions in expectations based on a company's long-term cash flows and competitive strategy. Mauboussin highlights the significant shift towards intangible investments and the need for a more comprehensive valuation approach that accounts for these investments. He outlines a three-step process for implementing Expectations Investing, which involves estimating price-implied expectations, identifying opportunities, and making buy/sell decisions based on the margin of safety. The talk also touches upon real options and reflexivity, emphasizing the importance of understanding how stock prices can influence a company's fundamentals.
Detailed Summary:
1. Introduction and the Big Idea:
- Mauboussin shares his professional epiphany, inspired by Al Rappaport's book "Creating Shareholder Value," which emphasized the importance of understanding cash flows, competitive strategy, and market expectations.
- He introduces the concept of Expectations Investing, stating that stock price changes are driven by revisions in expectations.
- The key task for investors is to anticipate these revisions, focusing on a company's long-term cash flows and competitive strategy.
2. The Changing Landscape:
- Mauboussin highlights the significant changes in the market landscape over the past 20 years, with the emergence of new technology companies and a shift towards intangible investments.
- He presents data showing the increasing importance of intangible investments compared to tangible investments, emphasizing the need for a more nuanced approach to valuation.
- He discusses the decline in discount rates and the implications for equity returns, suggesting that equities may be more attractive than debt in the current environment.
3. What Drives Value:
- Mauboussin emphasizes the importance of understanding free cash flow, which represents the pool of cash available for distribution to all claim holders.
- He explains the limitations of traditional income statement-centric analysis and the need to consider investments, particularly intangible investments, which are increasingly showing up on the income statement.
- He uses Microsoft as an example to demonstrate how accounting for intangible investments can significantly impact a company's earnings, invested capital, and return on invested capital (ROIC).
4. Why Doesn't Everyone Do This?
- Mauboussin discusses the common pitfalls of traditional valuation methods, such as relying solely on multiples and neglecting discounted cash flow (DCF) models.
- He argues that DCF models, despite their perceived complexity, offer a more transparent and explicit approach to valuation compared to multiples.
- He emphasizes the importance of using available tools and base rates to inform expectations and decision-making.
5. Implementing Expectations Investing:
- Mauboussin outlines a three-step process for implementing Expectations Investing:
- Step 1: Estimate Price-Implied Expectations: Use a DCF model to understand the market's expectations for a company's future cash flows.
- Step 2: Understand Expectations Opportunities: Analyze historical trends, competitive strategy, and value triggers to identify potential opportunities.
- Step 3: Make Buy/Sell Decisions: Compare the expected value with the current price, using the margin of safety as a guide.
- He provides a framework for analyzing value triggers (sales, costs, and investments) and value factors (volume, price, mix, operating leverage, economies of scale, cost efficiencies, and investment efficiencies).
- He emphasizes the importance of considering scenarios and assigning probabilities to potential outcomes.
6. Beyond Discounted Cash Flow:
- Mauboussin discusses the concept of real options, which can be valuable in situations with uncertain markets, capable management, and access to capital.
- He suggests that real options can be incorporated into the DCF framework by back-testing the market's implied option value.
- He highlights the importance of reflexivity, where stock prices can influence a company's fundamentals, using Tesla as an example.
7. Across the Economic Landscape:
- Mauboussin presents a taxonomy of businesses based on their competitive advantage sources: physical, service, and knowledge.
- He explains how the investment triggers and scale economies differ across these categories.
- He discusses the importance of understanding capital allocation, particularly in the context of mergers and acquisitions (M&A) and share buybacks.
8. Conclusion:
- Mauboussin encourages investors to consider Expectations Investing as a disciplined and comprehensive approach to valuation.
- He emphasizes the importance of understanding market expectations, anticipating revisions, and incorporating intangible investments into the analysis.
- He highlights the value of real options and reflexivity in understanding the dynamic relationship between stock prices and fundamentals.
- He concludes by emphasizing the importance of considering ESG factors and seeking win-win opportunities for both shareholders and society.