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How is "Expectations investing" different from investing?


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If you're on COBF you're probably familiar with Mauboussin's expectations investing. The idea is that you begin with the stock price, figure out what expectations are built in to the stock price, and then compare with your expectations & estimate of stock value. What I don't understand is how this is any different from calculating fair value, and then comparing with the stock price. It's the exact same thing. I've read the book, I've listened to MM's interviews, I've read reviews, and I can't figure out how his process differs from ordinary stock picking. He's rebranded the platitude "hear both sides of the argument"  as "Expectations Investing." It really is a great trick.

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I sense some of the expectation side is variable. The FANGs IMO are a great example of this, as are biotechs. You buy these with either faith that the market is efficient(not me) or a vague understanding of the variables that influence it’s valuation. Probably more in the category of event driven trading, but as those variables change you can sometimes anticipate big moves. 

For instance many of the CRISPR stocks have a big value assigned to them because many in the community believe it to be a once in a generation type breakthrough. If something newer and better comes along sooner,  even if just in the conceptual infancy stage, for little other fundamental reason, I’d probably imagine a lot of valuation hair cutting even if the specific treatments continue to show promise. 

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Here is his explanation of the non-expecatations approach:




"Having been on the sell side for many years and then on the buy side, I can say categorically that the single
greatest error I have observed among investment  professionals is the failure to distinguish between
knowledge of a company’s fundamentals and the expectations implied by the company’s stock price. If
the fundamentals are good, investors want to buy the stock. If the fundamentals are bad, investors want to
sell the stock. They do not, however, fully consider the expectations built into the price of the stock.
Whenever I assert that stock prices are based on expectations, investment professionals shrug their
shoulders and say, “Well, of course. That’s obvious.” But as obvious as the assertion sounds, few investors
take the time to understand those expectations and determine whether they make sense.


So the non-expectations approach is "Buy a good story, sell a bad story," which probably isn't the worst advice, but it's not a position that anybody would defend.


I think Mauboussin is actually trying to sneak in a slightly stronger claim under the heading of "expectations investing." The stronger claim is that there is information in the stock price and an investor is better off "updating priors"  than dismissing it as irrational. That would be a more interesting argument but he probably doesn't spell it out because he doesn't want to be associated with momentum investing.

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Mauboussin  is definitely into updating priors. He mentions this several times and it is also something 

that I have heard in several economics books that deal with forecasts.


I think the expectation investing is a twist to value investing where you try to reverse engineer the stocks value as well, as embedded expectations in a stock. You can apply this such that it’s not directly value investing and I think quite a few growth investors do this as well, It’s similar to a DCF or reverse DCF method- both can give the same result and it’s fundamentally the same method , but require a bit of a different way of thinking. Mungers “invert, always invert” fits the same framework.



FWIW, there is a recent podcast interview from Mauboussin:


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Yea I think those are good descriptions. You are basically valuing what you can’t value in the entire equation but rather than doing the typical value investor thing and claiming that this figure represents an overvaluation, you are assigning it to “something”.

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I like a good story that's based on my realistic expectations.


A business is a good investment when it has products and / or services that address the wants and needs of a large TAM (while maintaining the ability to fend off competitors), and has proven ability to design, manufacture and deliver at a profit, while managing its balance sheet and cash flows responsibly and intelligently. Having significant opportunities to reinvest cash flows at attractive returns for an extended period of time is a huge gravitational slingshot.


It all boils down to whether I expect this business to continue operating successfully or not. The best times to enter are when a big herd rolls through with a bad attitude or as in the case of BRK, the business fails to excite the imagination of the broader market (DCA in and wait for the scales to tip).


The best and most prominent professionals make huge mistakes all the time. Bad behavior is the enemy of good performance. I expect that I'll behave badly from time to time.

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