Expectations Investing: Reading Stock Prices for Better Returns

The authors provide a thorough examination of the fundamental analysis process. The first part of the book goes through the steps in creating a discounted cash flow model:Sales growth combined with operating profit margin = Operating ProfitOperating profit - cash taxes = NOPATNOPAT - investments in working/fixed capital = Free Cash FlowFCF discounted at cost of capital = Corporate ValueCorporate Value + non-operating less market value of debt = Shareholder ValueCost of Capital calculation weights debt from equity based on a companies financing mix:CC of Debt = yield to maturity of your debt * (1 - tax rate)CC of Equity = Risk free rate + Beta * (Expected market rate of return - risk free rate of return)Expected rate of return would be backed into by a market index.While this sounds confusing, the book gives easy examples to illustrate their points. From this, the authors speak to other considerations such as Porter's Five Forces and competitive analyses that can be used to tweak a DCF model. Other issues are then extrapolated out of this foundation:- When to take on new investments? (when they yield more than the cost of capital)- How do you add in stock options? (add issued options as debt and future options as expenses)- How do you look at a merger? (Use Shareholder Value at Risk which uses the premium paid / the market value of the acquiror).This all makes the book well worth reading. I admire the focus on first understanding the basics and then seeing how you can tweak the market's expectations to get better returns. I would caution that I do not think this book, nor any other, will lead to superior alpha but this book does a great showing how many considerations must be made for proper valuation.

An interesting read for the serious investor. The central tenet of the book might be stated as "investors do not earn superior rates of return on stocks that are priced fully to reflect future performance - even for the best value-creating companies - which is why great companies are not great stocks." This book posits that investors can read market expectations contained in a stock's price and anticipate revisions in those expectations to achieve superior returns. It book provides a detailed, step-by-step way to accomplish this process."Expectations Investing" is divided into three parts. Part I details how to determine the expectations for a stock based upon its current market price. Interestingly, rather than determine a "fair price" based upon a company's free cash flow, the book turns this process upside down, using a company's stock price to determine the market's expectations for free cash flow going forward. Next, the book helps identify "expectations opportunities" - places where revisions in the stock market's expectations are likely to take place. By focusing on key areas where expectations opportunities may take place (so-called "turbo triggers"), the skilled investor can modify their discounted cash flow projections to determine the appropriate price. This section further provides a framework to determine when to apply buy, sell, and hold decisions. Lastly, Part III of the book explains how certain, specific corporate events (mergers, share buybacks, and incentive compensation) may signal that expectations revisions are in order.Within the book itself, I found the chapter on "Analyzing Competitive Strategy" to be an outstanding, investor-focused distillation of many of the points contained in Porter's "Competitive Strategy." Moreover, the chapters on specific corporate events were interesting insofar as they explain, in greater detail than I had read before, the quantitative analysis that underlies decisions related to mergers, share buybacks, and incentive compensation.Potential readers should be aware that the authors of this book, like many stock analysts, adhere to the so-called "Capital Asset Pricing Model" school of thought (that the value of a security equals the rate on a risk-free security plus a premium, beta, which is determined based upon the volatility of the security in question). This model is just one of many that investors may use. Moreover, although stock analysts may have access to customers, creditors, competitors, and company insiders, many individual investors will lack those contacts, and thus face some difficulty in determining possible expectations revisions. Even if an investor had access to such information, the developing field of behavioral finance (see Belsky and Gilovich, "Why Smart People Make Big Money Mistakes" as but one example) would caution that investors seeking to implement the methods set forth in this book need to be careful of confirmation bias (tending to view information in a way that supports their pre-determined preferences) and information cascade (too much information), among others.Lastly, readers should be aware that modeling out the process described by this book requires some math, and the ability to create spreadsheets of middling-level complexity. This is not a "buy low P/E" book - readers will have to do their homework to use these methods. Anyone who isn't looking to put several hours into investigating each stock they are interested in should look elsewhere.In all, this is a well-written book that makes a very complicated process relatively simple. It is not designed for the casual reader, and implementing the expectations investing process certainly takes considerable work. However, the book provides valuable insights into how analysts function and how stocks are priced by public markets.However, if forced to pick a well-written, fairly sophisticated book on investing, I'd recommend a few other books ahead of this one, including "Security Analysis" by Benjamin Graham and either of Martin Whitman's books ("The Aggressive Conservative Investor" or "Value Investing").

An observation by Peter L. Bernstein that the "fundamental law of investing is the uncertainty of the future" sets up the dilemma undertood by all investors grappling with risk in pursuit of gain. This book starts with the assumption that stock prices represent the market's expectations about a company's future performance. There are "price implied expectations" (PIE) embodied in the price of a stock. Defining the "value drivers" of these expectations, understanding how they contribute to a company's success, and anticipating revisions in their assessed effectiveness for a particular company are critical steps in this investment approach. Determining the PIE for a particular stock from publicly available information involves a range of estimates and a need to understand the industry sector. What we have here is an artful process for estimating value not fail safe equations. This is a challenging book on a number of fronts: Stock prices, we are told, only "tenuously" relate to earnings growth. Rather "changes in expectations about future cash flows" are the key, and earnings and shareholder value may not move together. On the other hand, the notion that a stock price can be deconstructed to establish the expectations investors have for its future seems intuitively clear. This reader would have been more persuaded of the usefulness of this analytical approach with more case studies where the ideas are comprehensively applied. Separate chapters dealing with acquisitions, stock buybacks, and employee stock options - each of which when properly interpreted can modify an investor's expectations - are especially insightful.

A mi parecer es un libro muy bien explicado para aquellas personas que no tienen una formación en el área de inversión. Tiene ejemplos sobre las herramientas que presentan los autores que son muy útiles para entender el tema.Hay que tomar en cuenta que este libro es solo un acercamiento de varios que existen para analizar el desempeño de empresas.

So much information. Not yet completed the book. Simply amazing. Simply buy this book and you will never regret it. Worth its weight in gold and even beyond. Wish I had read it much earlier. Thanks Ramdeo Agarwal for recommending this.

Excellent book on stock picking and must read for professional money managers.

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