Here is your weekly Saturday newsletter, where I share the latest updates from the site, an idea worth thinking about, few stories you shouldn’t miss, and a question for you. Let’s get started.

On SN This Week

• Think in Market Caps, Not Stock Prices
• Stock Prices: Information or Influence?

Idea: Fundamentals Vs Expectations
What really separates great investors from everybody else is their skill at comparing a given company’s “fundamentals” (i.e., sales growth, profit margins, capital structure, etc.) with the “expectations” implied by its stock price. As Michael Mauboussin writes in his paper on ten attributes of great investors –

Fundamentals capture a sense of a company’s future financial performance. Value drivers including sales growth, operating profit margins, investment needs, and return on investment shape fundamentals. Expectations reflect the financial performance implied by the stock price.

Making money in markets requires having a point of view that is different than what the current price suggests. Michael Steinhardt called this a “variant perception.” Most investors fail to distinguish between fundamentals and expectations. When fundamentals are good they want to buy and when they are poor they want to sell. But great investors always distinguish between the two.

Horse racing is a good example. The amount bet on a horse gets reflected in the horse’s odds, or probability, of winning the race. The goal is not to figure out which horse will win but rather which horse has odds that are mispriced relative to how it will likely run the race. Fundamentals are how fast the horse will run, and expectations are the odds. You need to consider those elements separately.

One way to separate fundamentals and expectations in stock investing is by performing a reverse DCF analysis, whose aim is to get the intrinsic value to match the stock’s current price – to find out what’s the free cash flow (FCF) growth estimates the stock market is pricing in the stock. So, rather than attempting to estimate how future FCFs might look over the next ten years, the idea is to estimate the level of growth currently implied into the stock price, and then correctly anticipate any changes that aren’t yet fully reflected in that price.

Of course, reverse DCF does not completely free us from the job of estimating cash flows. To assess the stock market’s expectations, we still need to have a good sense of what conditions are required for the company to deliver them. That said, it is a much easier task to judge the credibility of a set of forecasts/expectations rather than having to come up with them on our own.

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A Few Stories You Shouldn’t Miss

• Eight Timeless Buffett Contributions That Go Beyond Returns (Validea)
• We are What We Choose (Jeff Bezos)
• Money costs money (Seth Godin)
• Real estate will cost up to 50% less, minus bribes (Mint)
• What can Long-term Value Investors Learn from Traders? (Fundoo Professor)
• 13 Lessons Marcus Aurelius Learned From His Father (Ryan Holiday)
• Good Things Taken Too Far (Morgan Housel)

Meditations

What you should learn when you make a mistake because you did not anticipate something is that the world is difficult to anticipate. That’s the correct lesson to learn from surprises: that the world is surprising.

~ Daniel Kahneman

Some people seem to think there’s no trouble just because it hasn’t happened yet. If you jump out the window at the 42nd floor and you’re still doing fine as you pass the 27th floor, that doesn’t mean you don’t have a serious problem. I would want to address the problem right now.

~ Charlie Munger

A Question for You
A wise man said that if you have a big enough WHY (you do what you do), you will always find the HOW (to do that you want to do).

If you don’t have a BIG WHY, you will always use the What and the How as an excuse for not doing that thing you said you were going to do.

So, today, ask yourself – What’s my WHY?

That’s about it from me for today.

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Have a great weekend.

Stay safe.

With respect,
— Vishal

https://www.safalniveshak.com/fundamentals-vs-expectations/