Book review #14 of 2021: Expectations Investing by Michael Mauboussin

Reading stock prices for Better returns

Michael and Alfred Rappaport in the book provide intricate details of how to understand the mispricing of stocks from looking at the best indicator of a company – its own share price. This is a framework that helps in easing out “what’s factored in” and to put it in context I can say that Tesla’s stock price today captures a very high market share in the automobile industry even on Mars.

My entire finance education on valuations has been fueled by following the works of 2 people to who I was lucky to be introduced on the campus itself.  While Aswath Damodaran is the official Bhagavad Gita on valuation and part of all MBA curriculum.  I was lucky to be introduced to Michael Mauboussin way back in 2003 as part of a course project.  The project involved understanding one of Michaels’s framework called – Market implied competitive advantage period or MICAP and applying it to a sector in India to identify mispriced stocks.

The concept of MICAP is nowadays more loosely known as reverse DCF where instead of assuming DCF variables, we let the current stock price let us know what the market is assuming as growth/margins, etc.  I was so fascinated by the course that I spent multiple night outs figuring it out and was one of my best projects undertaken during my MBA.

Links to Michael’s articles

I strongly recommend all of Michael’s writeup and reports for understanding valuation and stock analysis.  Link to Michael’s paper on the Competitive advantage period on which my project was based ( Here ). One other paper that was my favorite is –   The economics of customer business

For more check out :

Understanding Key value triggers

A good equity analyst with experience is able to narrow down companies’ performance of 2-3 key variables at best.  These variables can change for a company over a period of time. While for a long period key variable for ZEE entertainment was advertising and pay-tv revenue growth; recently it has only been cash flows; pledge and Corporate governance. In the case of Dish TV, the key variable was ARPU and Churn and the company kept misreporting these 2 numbers by underreporting churn.  In the case of Bharti Airtel; the key variable during 2004-2008 was subscriber addition and incremental Ebitda margin; 2008-2014 was regulatory actions and spectrum pricing and recently just JIO actions on pricing.  I strongly recommend analysts follow the book to be able to narrow down key-value triggers for each company. 

How Aswath Damodaran messed up in Netflix

Aswath Damodaran put out a detailed valuation blog on Netflix in April 2018 pegging the value of Netflix share at US$173. However, the key investment hypothesis of Aswath in that report was that Netflix’s ability to contain its content costs would be the key value driver.

“In my earlier post on Google, I noted that every company has a value driver, one number that more than any of the others determines value. In the case of Netflix, the key value driver, in my view, is content costs. My value per share is premised not just on high growth in subscribers and continued subscriber value, but also on content costs growing at a much lower rate (of 3%) in the future. “

I had disagreed with the value triggers as I had strongly believed that content costs would continue to increase and the pace of subscription will be much higher. Aswath had projected the subscriber base of Netflix in 2020 to be 178 mn where the company actually ended up at 203mn.  No wonder the current stock price is 3X of Aswath Damodaran’s fair value.  The objective of this is to understand that zeroing in on value drivers is a very difficult exercise and requires a lot of experience and study and even the best can still get it wrong. 

Interesting Quotes from the book:

Market commentators and investment managers who glibly refer to ‘growth’ and ‘value’ styles as contrasting approaches to investment are displaying their ignorance, not their sophistication.  – Buffet.

Investors make short term bets on long term outcomes.

Forecasts usually tell us more of the forecaster than of the future.  – Buffet .

The most important thing to do when you find yourself in a hole is to stop digging.  – Buffet on the stupidity of averaging down.

Stock prices are not merely passive reflections; they are active ingredients in the process and determine the fortunes of companies.

1 Comment

  1. Did you get a fair understanding of how the MICAP is reverse calculated? As in, what the input variables (on the cash flow front) are to the DCF? I read Mauboussin’s original 1997 paper on the subject but it did not go into too much detail regarding the specifics involved. Thanks

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