EXPECTATIONS INVESTING by Michael Mauboussin and Alfred Rappaport
Author: Michael Mauboussin is the Chief Investment Strategist at Counterpoint Global, a division of Morgan Stanley Investment Management and adjunct professor of finance at Columbia Business School. Alfred Rappaport is the Leonard Spacek Professor Emeritus at Northwestern University’s Kellogg School of Management.
Book: Michael J. Mauboussin and Alfred Rappaport argue that investors should reverse engineer the usual investing process: Instead of valuing a company and comparing it with the market value they should understand what the market is discounting first, and then make their own assessment of the value drivers and come up with a variant perspective. After showing how to read expectations, the authors provide a guide to strategic and financial analysis to help investors assess the likelihood of revisions to these expectations. Their framework traces value creation from the triggers that shape a company’s performance to the impact on the value drivers. This allows a practitioner of expectations investing to determine whether a stock is an attractive buy or sell candidate.
Opinion: I think that Expectations Investing is one of the (very) few books about investing that is actually useful for investors. While the author starts with simple ideas in each chapter, things get complicated and the level of detail in some instances may be too high for non-technical readers (i.e., when discussing M&A, real options, or new accounting rules). But it may be this level of detail that makes it worthwhile for practitioners. Some of the new ideas I learnt / reinforced include: The Threshold Margin [1], Calculation of the Market Implied Forecast Period [2], The Turbo Trigger [3], The SVAR [4], or some insights about the valuation real options. I cannot agree more with Howard Marks in that “this book is a graduate-level course in intelligent investing". I think this is Mauboussin´ s best book (“More than you Know” is close), so I highly recommend it along with most of his papers.
[1] Threshold Margin: The level of operating profit margin at which a company earns its cost of capital – creates 0 value
[2] Market Implied Forecast Period: This is the number of year that the market is estimating on average to calculate the value of a company. This is NOT an arbitrary figure – it reflects the # of years that the market expects the company to generate ROIC>WACC. Thus, it can be calculated by doing a 2 stage DCF: one perpetuity of X years where ROIC>WACC, and a second one for the rest of the years where ROIC=WACC. Change the # of years with ROIC>WACC until you arrive to the market value.
[3] Turbo Trigger: The value trigger that is likely to create most value / drive most the valuation
[4] SVAR: Shareholder Value at Risk in an M&A transaction – the calculation and implications vary depending on the type of deal (stock / cash), and the position (buyer / seller).
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