I manage an investment partnership on behalf of a group of friends and family investors. My focus is companies that should almost “inevitably” be far larger and more profitable in 5-10 or more years but whose stock prices reflect relatively modest expectations.
I share my research on Implied Expectations. That includes company-specific updates on some of the companies I own, my posts about new companies I haven’t written about before, notes from my conversations with industry participants, and extensive scenario analysis and valuation work. The content is focused on product, strategy, management, competition, and how companies may evolve over the long term.
You should expect 1-2 posts per month or sometimes more if it is earnings season and/or circumstances warrant. This is about quality, not quantity.
The Implied Expectations approach to valuation focuses on the long-term business expectations implied by certain stock prices.
The following two facts guide that approach:
- The value of any business is the present value of all future cash flows from now until eternity.
- The future is uncertain.
If value depends on the future and the future is uncertain, how can investors hope to intelligently value businesses?
The answer is the utilization of long-term scenario analysis with explicit assumptions, and discounting the cash flows to value the business in each scenario. This allows us to understand the kind of expectations that might be priced in to any given stock price, and what sort of future we need to bet on to earn attractive returns.
The most common counterarguments about this approach sound like this: “Predicting the future is impossible,” “garbage in, garbage out,” and “DCF is like a telescope—you move it a fraction of an inch and you’re in a different galaxy.”
All true. But consider the alternatives.
We can value businesses, like many investors do, by using multiples of some near-term financial metric like earnings. One might take comfort in that approach because it avoids the need to make long-term assumptions. But the truth is, we make just as many long-term assumptions by using a multiple—we just don’t know what they are.
Multiples make the long-term assumptions implicit, hiding them from scrutiny. The investor does not have a good sense of—or even need to consider—what different valuations might imply about critical metrics like store or subscriber count at maturity, long-term pricing power, operating leverage over time, capital efficiency, tax rates, or new business lines. Hiding these assumptions makes it impossible to understand what a given valuation implies about the future, which makes it easy to value companies using unrealistic assumptions.
With long-term scenario analysis, we can try to understand what sort of expectations could be baked into the current stock price—or a stock price far lower or higher. And by making our long-term assumptions explicit, they can be considered, debated, and revised with new information or evolving viewpoints. We can understand which value drivers move the needle more than others, and we can conduct more meaningful post-mortem analysis by seeing where our prior assumptions were wrong. That detailed feedback on prior expectations versus the reality that played out may improve our forecasting skills.
Long-term scenario analysis also allows individuals to evaluate various sets of expectations for themselves. I might be willing to bet on one future, but you may not be. That’s a productive and valuable debate—far more than arguing about the right multiple—because it allows each of us to have greater justification for, and confidence in, our decisions.
Most importantly, long-term scenario analysis allows us to understand the extent to which our own expectations differ from market expectations, which helps inform us of the prices we would pay for certain businesses.
None of this is easy. Investing is not easy. No one’s view of the future is exactly right. But we can increase our odds of success if we have a better understanding of the implied expectations.