Expectations Investing has two audiences: for a business school finance student, it’s a “how to” book. For an individual investor, it’s a “how to think about the markets” book. The book provides a deep analysis of free cash flow, the underlying basis of stock valuation. The basic approach is to compute how many years of free cash flow growth are embedded in the current market price of a stock, using a discounted cash flow analysis. As the authors observe, this is in contrast to the conventional practice of discounting a fixed growth period of five or ten years. The benefit of the conventional approach is that it facilitates comparisons between companies; the authors’ approach focusses on a detailed analysis of the company under review. The two approaches are not in conflict: the conventional approach can be used to screen for candidates, with those that look promising selected for the more intensive focus detailed in the book.
The book provides considerable insight into the strategies management can use to enhance free cash flow beyond the basic requirement of having a good product. I found these examples, which are backed up by the math, to be very helpful.
The authors present two case studies of their analytical methodology, leaving to the reader the job of deciding based on the presentation whether an investment is warranted. The first of these, Domino’s Pizza, certainly had solid credentials. Out of curiosity I compared an investment in Domino’s with Yum Brands, the owner of its chief competitor, Pizza Hut, and McDonalds, the largest fast food chain. The case study is as of August 2020. The results from September 1, 2020 to July 22, 2022 show Domino’s with a slight loss, while Yum had an annual return of about 14% and McDonalds, 11.75%. For reference, the S&P 500 annual return for this period was about 8.25%.
The second case study is of one of the highest fliers of the last few years, Shopify. Deconstructing the market price using even the most optimistic growth estimates still left a value gap, which for extreme growth companies can be analyzed according to the authors by using an option pricing model. Even this approach did not create enough value to justify the market price. The study was as of October, 2020. From November 1, 2020 through the end of 2021 Shopify produced positive returns but crashed in 2022 not only because of general market conditions but a decline in its free cash flow production. Overall its annual return was negative 40% through July 22, 2022.
I was certainly surprised by Domino’s performance. At the time of the study, both McDonalds and Yum prices were “cheaper” than Domino’s in having a lower implied number of years of growth (or a lower growth rate) so I suppose the lesson to be drawn is that one should carefully look at bargain alternatives. The Shopify result is not surprising. At its price in 2020 it was a classic bubble. Nor is it surprising that it continued to gain in price through 2021: bubbles persist beyond any analytical framework. The lesson to be drawn is to stay away from bubbles.
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Reviews with images
If you bought the first edition careful consider buying the second edition
What I find most pleasing about the book is the premise to reverse engineer stock prices to determine the intrinsic value of a company (see attached photo). In the vast sea of financial books here is one devoted to investing not trading. Most people believe that when they buy a stock that they are investing - actually in the current environment of index via ETF and mutual funds purchases there is little incentive to do the hard work of knowing what you are buying.What was most disappointing is that there was very little difference between Edition 2 and Edition 1.In addition, the book favors institutional investors rather than the individual investor. The buy, sell and hold section reads like a Harvard MBA case study. But there are very valuable nuggets which may enable the individual investor to build a sensible framework for buying long term equity holdings. Overall, the book does an excellent job in supporting its underlying premise and the authors should be commended for providing an approach for rational investing.
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Reviewed in the United States on July 25, 2022
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Reviewed in the United States on January 15, 2022
What was most disappointing is that there was very little difference between Edition 2 and Edition 1.
In addition, the book favors institutional investors rather than the individual investor. The buy, sell and hold section reads like a Harvard MBA case study. But there are very valuable nuggets which may enable the individual investor to build a sensible framework for buying long term equity holdings. Overall, the book does an excellent job in supporting its underlying premise and the authors should be commended for providing an approach for rational investing.
If you bought the first edition careful consider buying the second edition
Reviewed in the United States on January 15, 2022
What I find most pleasing about the book is the premise to reverse engineer stock prices to determine the intrinsic value of a company (see attached photo). In the vast sea of financial books here is one devoted to investing not trading. Most people believe that when they buy a stock that they are investing - actually in the current environment of index via ETF and mutual funds purchases there is little incentive to do the hard work of knowing what you are buying.Reviewed in the United States on January 15, 2022
What was most disappointing is that there was very little difference between Edition 2 and Edition 1.
In addition, the book favors institutional investors rather than the individual investor. The buy, sell and hold section reads like a Harvard MBA case study. But there are very valuable nuggets which may enable the individual investor to build a sensible framework for buying long term equity holdings. Overall, the book does an excellent job in supporting its underlying premise and the authors should be commended for providing an approach for rational investing.
Images in this review
Reviewed in the United States on November 1, 2021
Top reviews from other countries
Cesar
Crystal clear book about stock investing
Reviewed in Spain on November 9, 2023
GD
very important book for serious fundamental investors
Reviewed in India on August 6, 2022