Material changes in the present value of expected cash flows are the key driver of material changes in a stock price. Accordingly, determining the investment merit of a given stock boils down to identifying gaps between the investor’s expectations for future financial performance and the market’s expectations.
Ergo: The best long-term strategy for making money in the stock market is: “Buy low expectations and sell high expectations.”
Sounds easy…but it is not easy…or everyone would do it, right?
There are two key challenges to executing this strategy:
1. Measure the true profitability of the business. Details on how we do that are here: translating accounting data into economic earnings.
2. Measure the future cash flow expectations embedded in the stock price. See How Our Reverse DCF Model Works for details on our how we do that.
Our models focus on quantifying the expectations for future cash flows embedded in the market price or any target price.
Clients can also analyze expectations using multiple forecast scenarios. All of our models are pre-populated with forecasts based on consensus estimates wherever possible.
Understanding the expectations for future cash flows embedded in stock prices is not possible with accounting data or any ratios (e.g. P/E, EBITDA, etc) based on accounting data.
For more details on how we find stocks with “low expectations” as well as super-high expectations, see Investment Strategy 101.