My top 3 lessons* on investment and valuation from Michael Mauboussin
“Repetitio mater studiorum est” which translates from Latin as “repetition is the mother of learning“ used to be the favourite expression of one of my professors at the university.
The core principles of prudent investing and valuation are not that complicated to master. However, getting reminded about the basics always brings a novel perspective and new thoughts. Even better, when these thoughts are formulated and articulated clearly and crisply as Michael does it.
Michael Mauboussin is an investment strategist and adjunct professor of finance at Columbia Business School. He has written several books, one of which, co-authored with Alfred Rappaport, has a title ”Expectations Investing: Reading Stock Prices for Better Returns, Revised and Updated” and is available here (and, yes, I might be receiving a commission for recommending it).
Here are my 3 takeaways after watching extracts from Michael’s conversation with Jack Forehand and Matt Zeigler (both from the Excess Returns podcast) on YouTube:
Lesson #1
The share price is the only certainty that you have. The price is all about the expectations. When evaluating an investment opportunity you have to remember that you are not at the point zero and this is not about going forward only. You are in the middle of the road and the company has followed a certain path to get there.
Expectations are embedded in the share price and you can reverse engineer what had to happen to arrive at this price. A discounted cash flow analysis can be used for that purpose. Only then can you perform strategic and financial analysis to understand whether the company can meet the expectations or not. Preparing different scenarios and assigning probabilities can help to make an educated guess about the investment opportunity.
Lesson #2
As a result of a major stock market shift over the last few decades, the intangible, as Michael calls them, businesses now outnumber the tangible businesses by a wide margin.
For a long time, investors shunned intangible businesses because of lower earnings ignoring the difference in accounting treatment. Intangible businesses tend to expense their R&D and marketing customer acquisition costs. The faster they grow, the more they lose money. You have to look at the basic unit of analysis and understand the economic proposition and the cash flows to make the right investment decision. It is not enough just to look at the income statement.
Both, Walmart and Amazon have done a terrific job in building profitable businesses for the long term. When compared, Amazon has done better on a free cash flow basis, while Walmart has been better on an accounting basis.
Lesson #3
It is almost impossible to have a casual conversation about investing or company values without referring to multiples. However, multiples are not a substitute for valuation. At best, they are a shorthand used for the sake of convenience.
There is a lot of implicit information about economic assumptions disguised in the multiples. The same assumptions that need to be explicit to be used in a DCF valuation. You have to understand them before making an investment decision. You have to understand them to have an edge. You have to understand them to earn the right to use multiples.
And, as a final note, a quick reminder about the differences between investment and speculation. Investment is buying a partial stake in the business with an expectation that value will grow over time. Speculation is buying something just with the hope that its price will go up. There is nothing wrong with either, but you have to be clear about what it is that you are doing and why. In practice, most investors, according to Michael, do a combination of both.
For those willing to try and pick top lessons of their own here is the link.
* from anything that you are reading, watching or hearing you can realistically expect to remember only a limited number of things. My solution is to pick just 3 items or ideas from any material. This number is non-negotiable. Even the most extraordinary experience gets compressed into 3 things to remember. This approach has worked well for me.
This note was first published on Medium.com on 19 October 2024
