How do you determine what is priced into a stock?
Hi everyone! The title says it all. I am curious about the framework professional investors use to determine what is baked into a potential investment. What is your process for figuring out why certain equities may be mispriced?
Talking to other investors, looking at sell-side consensus, backing out values using other more known variables
reverse DCF
The only correct answer is PIE — price implied expectations. Reverse assumptions via reverse multiple or reverse DCF.
Say you build an operating model and develop a thesis to forecast your DCF inputs for FCFF:
1. Revenue
2. Operating margins
3. Tax rate
4. D&A
5. Capex
6. OWC
Then calculate your discount rate and assume an exit multiple. And say you build strong conviction based on your thesis around certain inputs (I.e. multiple is very resilient so maybe tiny contraction in 5 years for more mature co).
But in this case as far as I know you can use goal seek to iterate and find one implied variable - say goal seek for revenue growth to arrive at the current price. That’s only one input.. with all the possible combinations of variables impacting the value how do you best decide what the market is pricing in?
Do you just manually iterate and try different scenarios? Seems nebulous to me but trying to learn. Thanks!
Could be an absolutely stupid question from me but would technical analysis help in this regards?
Often sell side consensus is not buy side consensus and when a company beats on some metric, the stock might actually fall on the day of earnings. How do you back out the actual buy side expectations on a name and determine whether something is a good trade / good RV?
It's an art not a science. Sector sales specialists at the banks/brokers can often be helfpful identifying which names are most crowded on the long and short side. Many of them shoot out earnings season previews for the sector listing this out and detailing what they think the "buy-side bogey" is for EPS, top line, etc.
Its more art than science. Before you get into reverse valuation techniques you need to know the business and the current narrative.
you want to look for stocks that have low implied expectations that you can build a differentiated non-consensus view on. opposite if you're looking for shorts.
screen for low expectations by looking for PVGO as % of EV. Lower the %, the lower the expectations implied. Be aware of value traps and do your solid qualitative work.
Again, there really isn't a right or wrong way to do this. GL
Price-implied expectations
https://www.expectationsinvesting.com
there is no clear answer to this. essentially, you need to be 200% sure that your EPS estimate is accurate and the consensus is wrong, then you know what is or isn't priced in. The tricky part is that you don't know how accurate your earnings estimates 2-3 years out will be. for eg., no one could have known that Nvidia's EPS could grow 10x this year in 2022 when ChatGPT had not been released yet. the AI arms race only started in 1Q23 when all CSPs decided to buy huge amounts of GPU.
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