Revised & Updated for a New Generation of Investors
Endorsements, bonus chapters, and a chapter-by-chapter guide to what's inside—and what's new.
What Investors Are Saying
“In Expectations Investing, Michael Mauboussin and Al Rappaport break down investing into its component parts, explaining what makes for good companies and attractively-priced stocks. Which isn’t to say they make it easy. This is second-level thinking: a graduate-level course in intelligent investing.”
Howard Marks, Chairman and Cofounder, Oaktree Capital Management, and author of The Most Important Thing
“Mauboussin and Rappaport’s approach to corporate valuation is as relevant and intelligent today as ever. Understanding expectations, assessing competitive strategy, appreciating optionality, and a laser focus on cash flow will make you a more effective investor in private or public markets.”
Bill Gurley, General Partner, Benchmark Capital
“In Expectations Investing, Michael Mauboussin and Al Rappaport build off the simple yet powerful observation that a company’s stock price embeds expectations. They then offer investors a rigorous method to identify gaps between what the price reflects and what is likely to happen. Truly a must have in any investor’s library.”
Annie Duke, author of Thinking in Bets and How to Decide
“One of the few investing books that gave me an ‘ah-ha’ moment and changed how I think about investing.”
Morgan Housel, Partner, The Collaborative Fund, and author of The Psychology of Money
“Expectations Investing was one of the first books that sparked my interest in investing. The core idea is as powerful as any, and the authors explain it in a way that makes it unforgettable. This excellent update to the original classic is a must read for all investors.”
Patrick O'Shaughnessy, CFA, CEO, O'Shaughnessy Asset Management, and author of Millennial Money
Bonus Chapters
This section offers extra chapters that were not included in the final version of Expectations Investing. Click a chapter to view it as a PDF.
Chapter Summaries
Chapter 1The Case for Expectations Investing
Highlights the case for the approach. Here it is in a nutshell: Expectations investing is a stock-selection process that uses the market’s own pricing model, the discounted cash flow model, with an important twist. Rather than forecast cash flows, expectations investing starts by reading the expectations implied by a company’s stock price.
The chapter goes on to enumerate the limitations of current practice in active management, covers some fallacies (most about earnings per share and price/earnings multiples), and lays out the three steps of the expectations investing process. The appendix shows that growth and value creation are two different things.
What’s new: statistics and data are updated and there is a new example of the earnings-cash flow gap.
Keywords: expectations investing, discounted cash flow, active management, investment fallacies, value creation
Chapter 2How the Market Values Stocks
Provides the case for the discounted cash flow model as well as detailed definitions of the model’s elements. This chapter deals with the nuts and bolts of a DCF model, which have not changed. The appendix deals with various approaches to estimating continuing value.
What’s new: examples use numbers similar to what we see today, the rise of intangible investment is mentioned, and the appendix is substantially updated to reflect developments in estimating continuing value.
Keywords: discounted cash flow, value drivers, intangible investment, cost of capital, continuing value, inflation
Chapter 3The Expectations Infrastructure
The expectations infrastructure allows analysts to capture the interactivity between value triggers (sales, costs, and investments) and value drivers by introducing value factors (volume, price/mix, operating leverage, economies of scale, cost efficiencies, investment efficiencies).
What’s new: all new examples to illustrate the concepts.
Keywords: expectations infrastructure, value triggers, value factors, value drivers, sensitivity analysis, scenario analysis
Chapter 4Analyzing Competitive Strategy
Provides a structured way to do competitive strategy analysis in order to assess whether expectations are proper. We use frameworks by Orit Gadiesh, Michael Porter, Bruce Greenwald, Clay Christensen, and Pankaj Ghemawat (among others).
What’s new: this chapter was substantially revamped, including lots of material we include in the report, Measuring the Moat, as well as concepts from Ben Thompson at Stratechery and Dan McCarthy on customer-based corporate valuation. Here again, new examples are used to reinforce key ideas. Sidebar on game theory also has new illustrations.
Keywords: competitive strategy, five forces, value chain, disruptive innovation, value pools, game theory
Chapter 5How to Estimate Price-Implied Expectations
This chapter explains how to execute the first step in the expectations investing process, estimating price-implied expectations. The chapter also introduces a new case study.
What’s new: the main new feature is the case study on Domino’s Pizza, replacing the original case on Gateway.
Keywords: price-implied expectations, discounted cash flow, expectations investing, market-implied forecast period, continuing value, Domino’s Pizza
Chapter 6Identifying Expectations Opportunities
Identifying expectations opportunities requires understanding historical performance, price-implied expectations, and use of the expectations infrastructure and competitive strategy analysis. This allows the investor to isolate the key value trigger and thoughtfully run scenario analysis. This chapter is very substantial, as it applies the frameworks to Domino’s Pizza. The chapter also touches on behavioral pitfalls to avoid. There are sidebars on price targets (mostly useless) and forecast horizon and cost of capital (and why investors should focus on cash flows).
What’s new: application of the approach to Domino’s Pizza. This includes a lot of new material that is concrete and therefore illustrative. The pitfalls section was fortified with new research, especially on overconfidence.
Keywords: price-implied expectations, expectations infrastructure, scenario analysis, key value trigger, competitive strategy, Domino’s Pizza
Chapter 7Buy, Sell, or Hold?
This chapter shows how to translate expectations opportunities into investment decisions by: 1) converting anticipated expectations revisions into an expected value for a stock; 2) comparing that value with the current stock price to isolate opportunities to buy or sell; and 3) specific guidelines for when to buy, sell, or hold stocks.
What’s new: introduce base rates into discussion, update discussion on loss aversion, and finish with the case of Domino’s Pizza.
Keywords: expected value, margin of safety, base rates, behavioral pitfalls, expected return, Domino’s Pizza
Chapter 8Beyond Discounted Cash Flow
Here we introduce the concept of real options and show how they complement the discounted cash flow model.
What’s new: option pricing models updated to reflect current volatility and interest rate environment, and brand-new case study using Shopify. Discussion of stock-based compensation also revised.
Keywords: options theory, real options, discounted cash flow, reflexivity, stock-based compensation, Shopify, Inc.
Chapter 9Across the Economic Landscape
Classifies businesses into three broad categories (physical, service, and knowledge) and highlights the distinguishing characteristics of each. Also analyzes the value factors that help us identify the most likely sources of meaningful revisions in expectations.
What’s new: the core concepts here have stood up well. The chapter is filled with new examples to illustrate the points.
Keywords: physical businesses, service businesses, knowledge businesses, intangible assets, reinvestment, rivalry and excludability
Chapter 10Mergers and Acquisitions
Shows that M&A, the largest recipient of capital allocation, is often poorly analyzed (i.e., focus on EPS growth) and provides a robust framework for assessing deals. Provides a specific checklist for assessing a deal’s impact and prospects for value creation.
What’s new: more concrete evidence that EPS ≠ value, the pros and cons of deal types, and new illustrations of SVARs for stock deals.
Keywords: mergers and acquisitions, premium, synergy, shareholder value at risk, deal categories, earnings accretion
Chapter 11Share Buybacks
Identifies when buyback announcements offer a credible signal to revise expectations, presents “the golden rule of buyback programs,” and applies the golden rule to evaluate the most popular reasons cited for share buybacks.
What’s new: updated data on buybacks (and dividends) over the past 20 years. Introduces the value conservation principle.
Keywords: share buybacks, golden rule of buybacks, dividends, value conservation, buyback motivations, earnings accretion
Chapter 12Sources of Expectations Opportunities
This is a new chapter that describes eight cases where revisions in expectations may be appropriate. These include macro shocks, changes in management, regulatory shifts, lawsuits, and stock splits and issuance. The genesis of this chapter is what we find ourselves discussing with students and investors that is not already in the book.
Keywords: macroeconomic shocks, management changes, regulation, lawsuits, stock splits, stock issuance