The Importance of Expectations in Investing

There is a common misconception that a good company is always a good investment. But that sometimes isn't the case. The reason for that comes down to the role that expectations play in investing. Companies with good fundamentals typically have high expectations built into their stock price, while companies with poor fundamentals typically have low expectations embedded in their price. But either way, the key for investors is identifying companies where there is a gap between expectations and reality. In this episode, we look at the importance of expectations in investing and how investors can look at this issue. We also look at some systematic ways to take advantage of the differences between expectations and reality. We hope you enjoy the discussion.

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[richardsampson]

Such a great podcast! Really appreciate your work

[HepCatJack]

At 4:00 do people really misprice stocks, or do they not like the hand that they are dealt (to make a poker analogy) preferring instead to play a better hand. Warren Buffett used a baseball analogy with the exception that he could get as many pitches as he liked taking a swing only when the ball was pitched in the sweet spot. Taking a swing at a mispriced stock, means that the funds are not available to take a swing at a better opportunity. A lot of times, I will see opportunities I like that I pass on because I just don't have the funds to allocate to them. Out of my 15 to 30 ideas, I end up picking one or two among them which have the best characteristics. Many times, those I rejected end up doing better than those that were ultimately selected.

This also makes me think of the argument between buybacks versus dividends. One one hand, when you have a dividend, there is a tax drag on the dividend (unless the stock is in a tax sheltered account). However with a buyback, you have no control over what the company will be purchasing stocks for. They may be overpaying for the stocks that they are purchasing (as was the case with GE at one time. The company making the buyback is making the assumption that of all of the companies in the market, the best company or fund to allocate your capital is their company at the current price. The odds are very high against that assumption. If management is selling its own shares in an over-priced buyback, they are essentially draining company funds into their own pockets. I think management should be excluded from being able to partake in a company buyback because of the conflict of interest. To some extent, I would prefer it if Berkshire paid a dividend because it is now too big to invest in things like CEF or small caps as a big multi-national but it isn't the case for the stock owner which is a considerably smaller entity.