Mauboussin Almanack

Mauboussin Almanack

Michael Mauboussin has changed the way we think (and not just about investing). His research is timeless and often early (writing about network effects 20 years ago or System I/II thinking ~7 years before Kahneman's Thinking, Fast and Slow was published). We are continually adding research, interviews, presentations below:

Foundation

DateTypeTagsFirmLinkSummary.
September 22, 2021
Book
Foundation
Independent
This revised and updated edition reflects the many changes in accounting and the business landscape since the book was first published and provides a wealth of new examples and case studies.
August 4, 2016
Research
Foundation
Credit Suisse
The world of investing and business has seen a great deal of change in the past 30 years. This report shares thoughts on the ten attributes of great fundamental investors.
June 11, 2013
Book
Foundation
Independent
Now updated to reflect current research and expanded to include new chapters on investment philosophy, psychology, and strategy and science as they pertain to money management, this volume is more than ever the best chance to know more than the average investor.
November 6, 2012
Book
Foundation
Independent
In most domains of life, skill and luck seem hopelessly entangled. Different levels of skill and varying degrees of good and bad luck are the realities that shape our lives—yet few of us are adept at accurately distinguishing between the two. Imagine what we could accomplish if we were able to tease out these two threads, examine them, and use the resulting knowledge to make better decisions.
October 6, 2009
Book
Foundation
Independent
So why is it so hard to make sound decisions? In Think Twice, Michael Mauboussin argues that we often fall victim to simplified mental routines that prevent us from coping with the complex realities inherent in important judgment calls. Yet these cognitive errors are preventable.
February 18, 2003
Book
Foundation
Independent
Expectations Investing offers a unique and powerful alternative for identifying value-price gaps. Rappaport and Mauboussin provide everything the reader needs to utilize the discounted cash flow model successfully. And they add an important twist: they suggest that rather than forecasting cash flows, investors should begin by estimating the expectations embedded in a company's stock price. An investor who has a fix on the market's expectations can then assess the likelihood of expectations revisions.

Most gifted books - Trio; source: The Knowledge Project #28:

BookAuthorSummary.
Steven Pinker
In this Pulitzer Prize finalist and national bestseller, one of the world's leading cognitive scientists tackles the workings of the human mind. What makes us rational—and why are we so often irrational? How do we see in three dimensions? What makes us happy, afraid, angry, disgusted, or sexually aroused? Why do we fall in love? And how do we grapple with the imponderables of morality, religion, and consciousness? How the Mind Works synthesizes the most satisfying explanations of our mental life from cognitive science, evolutionary biology, and other fields to explain what the mind is, how it evolved, and how it allows us to see, think, feel, laugh, interact, enjoy the arts, and contemplate the mysteries of life.
E.O. Wilson
Edward O. Wilson renews the Enlightenment's search for a unified theory of knowledge in disciplines that range from physics to biology, the social sciences and the humanities. Using the natural sciences as his model, Wilson forges dramatic links between fields. He explores the chemistry of the mind and the genetic bases of culture. He postulates the biological principles underlying works of art from cave-drawings to Lolita. Presenting the latest findings in prose of wonderful clarity and oratorical eloquence, and synthesizing it into a dazzling whole, Consilience is science in the path-clearing traditions of Newton, Einstein, and Richard Feynman.
Louis Menard
The Metaphysical Club is written in the spirit of this idea about ideas. It is not a history of philosophy but an absorbing narrative about personalities and social history, a story about America. It begins with the Civil War and s in 1919 with Justice Holmes's dissenting opinion in the case of U.S. v. Abrams-the basis for the constitutional law of free speech. The first four sections of the book focus on Holmes, James, Peirce, and their intellectual heir, John Dewey. The last section discusses some of the fundamental twentieth-century ideas they are associated with. This is a book about a way of thinking that changed American life.

All

DateTypeTagsFirmLinkSummary.
April 12, 2022
Research
Intangibles
Morgan Stanley
In this report, we apply a framework for categorizing earnings and investments based on recent academic research. We show that there is significant variance between industries, which is important for investors who rely predominately on multiples for valuation. Adjustments to the financial statements of a pair of companies showed a huge operating profit margin expansion for the one that is intangible intensive and an insignificant change for the one that is tangible intensive.
March 16, 2022
Research
Decisions
Morgan Stanley
Improving process is crucial in all cases if the goal is to achieve an outstanding long-term outcome. Feedback, defined as information used as a basis for improvement, is central to making the process more effective. In this report, we discuss multiple facets of process improvement, including getting the right people and helping them thrive, the role of organizational structure in fostering good decision making, and specific mechanisms to create feedback that sharpens execution. While we draw from principles in other fields, our primary focus is on the investment management industry.
January 27, 2022
Research
Capital Allocation
Morgan Stanley
The goal of this discussion is to think about how resources translate into growth. In general, companies and investors should think about the split between growth and maintenance spending in the context of a life cycle. Early on, resources are skewed toward growth and they shift to maintenance later on. As a result, larger companies grow more slowly than smaller companies do on average. Most executives and investors likely underestimate maintenance spending as the result of inflation and technological obsolescence. A company with a competitor that has spent the money to provide a better good or service has little choice but to match the competitor’s outlays. Further, technology companies constantly develop new versions of their products, with some of the cost allocated to R&D.
October 6, 2021
Research
Valuation
Morgan Stanley
The point of this report is that today’s accounting creates a huge gap between financial statements and what an investor needs to understand a business. This is despite the conceptual match between categories on the statement of cash flows and how businesses work. We will show how moving certain items from one category to another improves relevance without affecting the essential task of cash reconciliation.5 A clearer understanding of the cash in, cash out, and financing activities provides relevance and predictive value beyond the current standards. This analysis is important because an accurate measure of the magnitude of investment and profitability is essential to understanding the business.
October 5, 2021
Interview
Decisions
Morgan Stanley
We sit down with the one & only Michael Mauboussin to dive deep into his incredible body of work: untangling skill and luck, measuring moats, persistence of returns in venture capital, decision making and — particularly timely — expectations investing and how to think about valuations in the current 2021 market environment. (!!) Michael's work is maybe our most frequent carve out on Acquired, so we're pumped to finally have a chance to interview the man himself.
September 8, 2021
Research
Decisions
Morgan Stanley
This report focused on what contributes to wins in sports and the barriers to change that make teams slow to adopt those strategies. But the concepts apply to all organizations where the results of decisions occur with some probability. Here are some observations about what investment management organizations can do to learn and adapt:
August 3, 2021
Research
Valuation
Morgan Stanley
The intrinsic value, determined by the present value of future cash flows, attracts the price like a magnetic force. This means it is useful for investors to keep in mind the value drivers of a discounted cash flow model.
June 23, 2021
Research
Intangibles
Morgan Stanley
Our analysis of historical sales growth rates for U.S. companies reveals both of these results: higher growth and more dispersion, on average, for companies and industries with the highest intangible asset intensity. There are two main lessons for investors: First, it is important to be mindful of the potential shift in the base rate due to the rise of intangibles. Second, skillful investors may be able to identify the companies that will grow faster than expected, hence providing the potential for attractive returns.
May 19, 2021
Research
Valuation
Morgan Stanley
This report focuses on the customer as the basic unit of analysis in understanding value. The idea of customer lifetime value (CLV) has been around for decades, but we believe that our discussion is richer and more nuanced than what many companies and analysts present.
April 24, 2021
Presentation
Markets
Morgan Stanley
(Video) CFA Society of India
April 14, 2021
Research
Markets
Morgan Stanley
This report describes market-expected return on investment (MEROI), which measures the return at which the present value of a company’s profits equals the present value of the investments a company makes. This allows executives and investors to understand how high the bar is set for corporate performance.
January 31, 2021
Syllabus
CBS
Columbia Business School
December 21, 2020
Research
Valuation
Morgan Stanley
The weighted average cost of capital (WACC) and volatility (vol) generally move in rough lockstep, but 2020 is unusual because the cost of capital is well below its historical average and volatility is well above its historical average. Businesses that have real option value benefit from a lower discount rate on their current operations and from the higher volatility of the options available to them. In this report, we define real options, discuss what kinds of businesses are likely to have them, review the valuation implication of a particularly noteworthy set of conditions in 2020, and finish with a method to incorporate real options analysis into traditional valuation.
November 18, 2020
Op-Ed
Valuation
Morgan Stanley
Why value investing still works in markets – To buy something for less than it is worth is as useful as ever.
September 17, 2020
Presentation
Markets
Morgan Stanley
CFA Society of Switzerland
September 15, 2020
Research
Intangibles
Morgan Stanley
Understanding the return on investment helps with understanding a company’s future cash flows, but the challenge is that the mix of investment has shifted over time and is today more intangible than tangible. We discuss three essential aspects related to the rise of intangible investments: how to measure them, their main characteristics, and the implications for investors.
August 4, 2020
Research
Markets
Morgan Stanley
Over the past quarter century there has been a marked shift in U.S. equities from public markets to private markets controlled by buyout and venture capital firms. This change has had reverberations for asset managers, investors, executives, and policy makers. In this report we seek to answer the following questions: What have been the major drivers behind the shift from public to private equities in the U.S.? Why are there fewer public companies today than there were 25 years ago? What are the long-term trends in buyouts? What are the long-term trends in venture capital? Where do we go from here?
July 21, 2020
Interview
Independent
June 9, 2020
Research
Valuation
Morgan Stanley
Most investors value stocks using multiples and also seek to distinguish between value and growth stocks. But these practices obscure the important drivers of value, and very few investors have a clear sense of how revisions in expectations for those drivers change multiples. We focus on how changes in growth rates can affect P/E multiples, the idea that companies with substantial and attractive current investment opportunities lengthen their duration, and why the distinction between growth and value is muddled.
May 20, 2020
Research
Markets
Morgan Stanley
We address four myths or popular delusions in the investment industry: (1) Short-termism is rampant and deleterious: We hear this argument made a lot but often without concrete evidence, so we critically examine some of the claims to see if they hold up; (2) Dividends play a large role in equity returns over time: We show that price appreciation is the only source of investment return that increases accumulated capital; (3) Investing in money-losing companies is a bad idea: This is too simplistic, as some money-losing companies may still have attractive economics; and (4) The rise of indexing has made it easier to be an active manager: If the investors who have turned to indexing tend to be less skillful, the remaining investors are left competing against stronger competition, making it harder to generate alpha.
April 14, 2020
Research
Markets
Morgan Stanley
An investor’s success requires both skill and opportunity. We look at how investors can express skill and use dispersion to measure the opportunity set.
April 3, 2020
Podcast
CBS
Columbia Business School
Mauboussin discusses the economic impact of the coronavirus pandemic, the centralized implementation of public health solutions, using the expectations infrastructure to analyze companies, and more.
March 20, 2020
Research
Decisions
Morgan Stanley
To improve your forecasting skills, try decreasing noise. Analyzing superforecasters reveals forecasters can be trained to more effectively update their views, reduce bias, and reduce noise.
January 31, 2020
Syllabus
CBS
Columbia Business School
January 31, 2020
Interview
Decisions
Credit Suisse
Patrick O'Shaughnessy interviews Michael Mauboussin at Capital Camp 2019. They discuss ways to improve processes for thinking, decision making, and investing.
September 29, 2019
Interview
Foundation
Morgan Stanley
Book Discussion: More Than You Know - The main theme of More Than You Know is that thinking about the world through a multidisciplinary lens will make you a better thinker. It will make you a better person, a better parent, a better spouse. The metaphor I always like to use, which has been well used, is that of a toolkit. If you have a full toolkit containing different types of tools, no matter what problem you face, you’ll have the appropriate tool to try solve that problem. If you have just one tool or a couple of blunt tools, you’ll be using the wrong tools to try solve problems.
April 16, 2019
Research
Active/Passive
Blue Mountain
The shift from active to passive management remains one of the hottest issues in the investment industry. In this report we examine the shift from active to passive investing in bonds. The migration in stocks has received more attention than that in bonds because the move has been more dramatic. The transition in bonds has been less rapid because active bond investors have outperformed passive alternatives at a higher rate than equity managers have, even if much of that outperformance can be explained by exposure to risk premiums.
February 12, 2019
Research
Markets
Blue Mountain
If you buy or sell a security and expect an excess return, you should have a good answer to the question “Who is on the other side?” In effect, you are specifying the source of your advantage, or edge. We categorize inefficiencies in four areas: behavioral, analytical, informational, and technical (BAIT).
January 31, 2019
Syllabus
CBS
Columbia Business School
September 13, 2018
Research
Valuation
Blue Mountain
This report is about the EV/EBITDA multiple, or enterprise value divided by earnings before interest, taxes, depreciation, and amortization. It is a widely used and misused approach to valuation. We put EV/EBITDA in historical context, define terms, and describe some of the limitations of using the multiple. We then show how to relate EV/EBITDA multiples to sound theory. We continue by sharing empirical findings to demonstrate that the market reflects the economic drivers of value and showing how multiples of EV/EBITDA and price-to-earnings relate to one another. We finish with specific recommendations for how to use EV/EBITDA multiples as effectively as possible.
June 26, 2018
Research
Markets
Blue Mountain
This report discusses procyclicality, and especially its role in bubbles and crashes in financial markets. In economics, procyclical variables move in the same direction as the overall economy: Consumers, businesses, and investors are bold when economic conditions appear strong and timid in the wake of weakness.
March 31, 2018
Interview
CBS
Columbia Business School
December 20, 2017
Research
Decisions
Blue Mountain
We are in the business of making comparisons. If we want to generate alpha, then every single investment decision comes down to how that investment compares to an alternative. But what alternative should we use to compare? What is the best analog?
June 11, 2017
Research
Active/Passive
Credit Suisse
Gross profit yield, gross profit divided by assets under management, has drifted lower over the past forty years. This reflects a broad increase in market efficiency. As a result, fees have followed suit. You want to use active management when you feel you can assess manager skill and there is variability in gross profit.
May 11, 2017
Research
Decisions
Credit Suisse
To improve a team’s odds of success it is important to be mindful about how you create and manage the team. Effective teams have high cognitive diversity, which is valuable because it provides lots of tools for solving problems. The presence of psychological safety and dependability also predict success.
March 22, 2017
Research
Markets
Credit Suisse
There has been a sharp fall in the number of listed stocks in the U.S. since 1996. While listings fell by roughly 50 percent in the U.S. from 1996 through 2016, they rose about 50 percent in other developed countries. As a result, the U.S. now has a listing gap of more than 5,800 companies.
February 27, 2017
Research
Valuation
Credit Suisse
We suggest answering four questions in order to assess mergers and acquisitions: How material is the deal? What is the market’s likely reaction? How did the buyer finance the deal? Which strategic category does it fall into?
February 7, 2017
Research
Markets
Credit Suisse
Corporate longevity is an important consideration for investors as they assess valuation, position sizing within a portfolio, and the magnitude of sustainable competitive advantage. Turnover in the S&P 500 Index, a proxy for longevity, correlates to an index of innovation reasonably well but correlates to M&A activity even better.
January 4, 2017
Research
Active/Passive
Credit Suisse
Active managers must constantly consider who is on the other side of the trade. Research shows that fundamental money managers who take a long view and are truly active can deliver excess returns. It is essential to identify a repeatable source of edge and to align the investment process to capture that edge.
November 15, 2016
Research
Capital Allocation
Credit Suisse
M&A, capital expenditures, and R&D are the largest uses of capital for operations, and companies now spend more on buybacks than dividends. This report discusses each use of capital, shows how to analyze that use, reviews the academic findings, and offers a near-term outlook. We provide a framework for assessing a company’s capital allocation skills, which includes examining past behaviors, understanding incentives, and considering the five principles of capital allocation.
November 1, 2016
Research
Valuation
Credit Suisse
This report develops a systematic framework to determine the size of a company’s moat. We cover industry analysis, firm-specific analysis, and firm interaction.
October 19, 2016
Research
Capital Allocation
Credit Suisse
In this report we examine the sources and uses of capital for Japan, Europe, Asia/Pacific excluding Japan, and Global Emerging Markets. This extends our analysis beyond the United States, which we discussed in a prior report. Countries or regions with a high return on invested capital (ROIC) can fund a substantial percentage of investment internally whereas those with low ROICs must rely more on external financing.
June 14, 2016
Research
Valuation
Credit Suisse
Analysts are commonly too optimistic about earnings growth and often miss estimates by a wide margin. This report outlines a systematic way to assess earnings revisions with a specific emphasis on operating leverage. We cover the drivers of sales growth and then discuss the value factors, which determine the impact of sales changes on operating profit. To measure operating leverage, we examine the relationship between the change in sales and the change in operating profit for the top 1,000 companies from 1950 through 2014. We also examine eight sectors. Operating leverage and financial leverage together determine earnings volatility. Sales growth, profit growth, and value creation do not always go together.
April 5, 2016
Research
Decisions
Credit Suisse
The worlds of business, investing, and sports are awash in numbers, yet we rarely pause to consider what makes for a suitable statistic. We provide a way to think about the numbers you use and put them in a format that allows you to compare across domains. The first quality to seek in a statistic is persistence, which means what happens in the present is similar to what happened in the past. The second quality is that the statistic is predictive, or highly correlated with the outcome you are trying to achieve. The goal is to find a statistic that offers a robust combination of persistence and predictive value.
January 11, 2016
Research
Decisions
Credit Suisse
This report provides analytical guidance if one of your stocks increases 10 percent or more in one day relative to the S&P 500 Index. Such gains generally evoke strong emotional reactions and make sound decision making difficult. We provide the base rates for roughly 6,800 such events in the past quarter century. We refine the base rates by separating earnings and nonearnings announcements and by introducing quantitative factors including momentum, valuation, and quality.
December 16, 2015
Research
Decisions
Credit Suisse
Executives and investors perceive that earnings are the best indicator of corporate results. Earnings announcements convey information to the market, as measured by a rise in stock price volume and volatility, and the impact of that information has risen since 2001. Earnings have severe limitations as a measure of shareholder value. As a result, it is possible to increase earnings without creating value. This report shows the base rate of net income growth rates for the 1,000 largest global companies since 1950. We sort the companies into deciles, allowing for easy identification of an appropriate reference class. We provide a method to integrate company-specific views with the base rates to sharpen the quality of forecasts.
October 20, 2015
Research
Decisions
Credit Suisse
In this report, we examine four situations where individuals make poor choices and review the research to show where the brain makes those decisions. In each case, we present some ideas about how to overcome the potentially suboptimal choice.
September 28, 2015
Research
Decisions
Credit Suisse
Tetlock, along with his colleagues, participated in a forecasting tournament sponsored by the U.S. intelligence community. That work identified “superforecasters,” people who consistently make superior predictions. That’s the good news. The key to superforecasters is how they think. They are actively openminded, intellectually humble, numerate, thoughtful updaters, and hard working. Superforecasters achieve better results when they are part of a team. But since there are pros and cons to working in teams, training is essential. Instruction in methods to reduce bias in forecasts improves outcomes. There must be a close link between training and implementation. The best leaders recognize that proper, even bold, action requires good thinking.
September 1, 2015
Research
Competitive Advantage
Credit Suisse
This report provides a framework for estimating TAM through the process of triangulation using three methods. The first is based on population, product, and conversion. Next we examine a diffusion model, which not only addresses the absolute size of the market but also the rate of adoption. Finally, we discuss the usefulness of appealing to base rates as a reality check for optimistic estimates of TAM and growth rates.
July 22, 2015
Research
Decisions
Credit Suisse
First, I want to discuss what I call the “paradox of skill.” When we think of investing, most of us think there’s a dearth of skill. But, in fact, the problem is the exact opposite: there is too much skill. Second, I’ll discuss some qualitative ways to think about where excess returns may come from. These are broader ideas but may still be a useful way to frame investment decisions. Finally, I’ll touch on some more quantitative ways to think about identifying skill. Well, I’ll try to lay out a framework for doing so and then apply an idea or two to the framework.
June 25, 2015
Research
Decisions
Credit Suisse
We all face a similar challenge: how to pay attention to what matters so as to make sure that we make good decisions. There are lots of bids for our attention, and the introduction of technology in recent years means there are more beeps and buzzes to divert our focus than ever before. Failure to allocate attention properly in the short run can add up to problems in the long run. Hence, the theme for the Thought Leader Forum in 2015—“Attention: Pay Now or Pay Later.”
June 4, 2015
Research
Decisions
Credit Suisse
The quest for the Triple Crown of horse racing offers three lessons for an investment organization: Pay attention to the results of the past, recognize the value of diversity, Value = Probability x Price. The first lesson is to consider base rates in assessing future outcomes. The second lesson is to promote cognitive diversity and thereby avoid the equivalent of inbreeding in your organization. The final lesson is to focus on mispricing in investing.
June 2, 2015
Research
Capital Allocation
Credit Suisse
Capital allocation is a senior management team’s most fundamental responsibility. The problem is that many CEOs don’t know how to allocate capital effectively. The objective of capital allocation is to build long-term value per share. This report discusses each use of capital, shows how to analyze that use, reviews the academic findings, and offers a near-term outlook. We provide a framework for assessing a company’s capital allocation skills, which includes examining past behaviors, understanding incentives, and considering the five principles of capital allocation.
May 4, 2015
Research
Decisions
Credit Suisse
Successful active investing requires a forecast that is different than what the market is discounting. Forecasts about outcomes relevant to us commonly suffer from biases of optimism and overconfidence. Research reveals that consideration of the results for an appropriate reference class can enhance the quality of forecasts. Sales growth is the most important value driver for most companies. This report shows the base rate of sales growth rates for a large sample of companies over more than two decades. We sort the companies into deciles, allowing for easy identification of an appropriate reference class. We provide a method to integrate our views with the base rates to sharpen the quality of forecasts.
April 28, 2015
Interview
Decisions
Independent
Mauboussin shares his wisdom on parenting, daily routines, reading, and how to make better decisions.
March 17, 2015
Research
Decisions
Credit Suisse
The fundamental law of active management separates the sources of excess return into two parts: skill and opportunity. While the investment industry is in constant pursuit of skill, having lots of skill doesn’t pay off if opportunity is poor, and modest skill can yield attractive results if opportunity is rich. We examine three ways that investors can express skill: market timing, security selection, and portfolio construction.
February 10, 2015
Research
Markets
Credit Suisse
To be an active investor, you must believe in market inefficiency to get opportunities and in market efficiency for those opportunities to turn into profits. The Mr. Market metaphor is very powerful because it makes an abstract idea concrete, encouraging an appropriate way to think about markets. One way to animate Mr. Market is to consider the wisdom of crowds. What’s key is that crowds are wise under some conditions and mad when any of those conditions are violated. Diversity breakdowns, which can happen for sociological as well as technical reasons, lead to extremes. Look for cases where uniform belief has led to a mispricing of expectations and hence a way to make money.
January 15, 2015
Research
Decisions
Credit Suisse
This report provides analytical guidance if one of your stocks declines 10 percent or more in one day. Such drops tend to evoke strong emotional reactions and make sound decision-making difficult.
January 6, 2015
Research
Capital Allocation
Credit Suisse
Capital allocation is a senior management team's most fundamental responsibility. The problem is that many CEOs don't know how to allocate capital effectively. The objective of capital allocation is to build long-term value per share. In this report we examine the sources and uses of capital for Japan, Europe, Asia/Pacific excluding Japan, and Global Emerging Markets. This extends our analysis beyond the United States, which we discussed in a prior report.
November 18, 2014
Research
Markets
Credit Suisse
Short-termism is said to plague all parties in the investment community, including investment managers, companies, and investors. However, it is very difficult to prove. To assess and evaluate the impact of market short-termism, the right level of analysis is not what individuals say but rather what the stock market does. For many companies, a contraction in time horizon is a proper response to economic reality. Corporate executives and investors who suffer from short-termism are partners in a dance who are attracted to one another based on their characteristics. The holding period that is relevant in portfolio construction is the time an investor is exposed to an asset class, not the turnover for a particular stock or fund. We provide specific recommendations to deal with the pressures of short-termism for investment managers, companies, and investors.
September 10, 2014
Research
Decisions
Credit Suisse
The goal of this report is to explore the applicability of freestyle chess to the world of investing, where fundamental analysts are “man” and quantitative analysts are “machine.” More pointedly, might there be a way that investors can combine the strengths of fundamental and quantitative analysis while sidestepping the weaknesses?
August 6, 2014
Research
Foundation
Credit Suisse
The world of investing and business has seen a great deal of change in the past 30 years. This report shares thoughts on the ten attributes of great fundamental investors.
June 10, 2014
Research
Decisions
Credit Suisse
The theme in 2014 unites three inter-related concepts that are at the center of some of the most exciting research today: how to blend the ability of humans and computers, when to rely on instincts versus statistics, and how to train to make better decisions. The forum brought together leading thinkers from a range of disciplines, each of whom discussed one or more of these concepts.
June 4, 2014
Research
Valuation
Credit Suisse
Return on invested capital (ROIC) is one measure of a company’s capital efficiency. But value creation includes not only the spread a company earns above the cost of capital but also how much the company can invest. Proper calculation of ROIC requires handling a number of practical issues in a thoughtful and consistent fashion. ROIC analysis can provide insight into the sources of a company’s competitive advantage. A model of future ROIC should include reversion to the mean in most cases.
May 6, 2014
Research
Capital Allocation
Credit Suisse
Share buybacks and dividends are two methods to return cash to shareholders. Executives view the two very differently and are often unsure of the best way to proceed. Superficial media coverage and wide-ranging input from investors drives this confusion. This report answers frequently asked questions. This format allows us to cover the pertinent issues as well as address a number of canards that persist with regard to these topics. A company should retain its earnings if it can earn a rate of return that is above the cost of capital. But if shareholders can earn a higher rate of return on capital than the company can, the company should disburse the cash.
April 16, 2014
Research
Markets
Credit Suisse
In this report, we start by examining the turnover in the composition of the S&P 500, with a goal of understanding the causal factors behind the additions and removals. In light of these results, we consider whether turnover in the S&P 500 is a reasonable proxy for innovation. We find that while we can link turnover to an index of innovation, M&A appears to have a larger influence on the changes.
February 24, 2014
Research
Decisions
Credit Suisse
This report covers five common mistakes and offers concrete and actionable ways to manage them. You can think of these mistakes as the common reasons that investors veer from their investment process or cases where the processes themselves are incomplete.
January 29, 2014
Research
Valuation
Credit Suisse
The goal of this piece is to provide an analytical bridge between price-earnings multiples—really, multiples of any kind—and sound economic reasoning. We’ll start by looking at price-earnings multiples through a classic valuation lens, and will examine the two main components of that model. We’ll finish by discussing the role of multiples in considering price-implied expectations.
January 8, 2014
Research
Decisions
Credit Suisse
This report is about how to build, manage, and lead a team so as to make effective decisions. We will place special emphasis on investment committees, a group with a fiduciary responsibility to make financial decisions on behalf of beneficiaries. Most organizations form and operate teams with the best of intentions but fail to improve decision making because most participants in the group don’t know how to be effective. This is particularly true of team leaders.
December 6, 2013
Research
Markets
Credit Suisse
Our recent report, “How to Model Reversion to the Mean: Determining How Fast, and to What Mean, Results Revert,”2 argued that investors should take reversion to the mean into account when modeling the key drivers of corporate performance. These key drivers include sales growth, operating profit margins, and cash flow return on investment (CFROI). However, the report did not consider the implications of the patterns of reversion to the mean for shareholder returns. This report addresses that gap. We look at how changes in CFROI correlate with total shareholder returns (TSR) for more than 1,000 companies. TSR is the annual shareholder gain including share price appreciation and dividends. Our goal is to understand the link between corporate performance and stock price in order to help investors anticipate future sources of excess returns.
October 15, 2013
Research
Decisions
Credit Suisse
Outcome bias occurs when people judge outcomes without considering the true quality of the decision. This bias is rife in business, investing, sports, and politics. There is a module in the left hemisphere of the brain called “the interpreter” that takes any effect that it sees and effortlessly and rapidly creates a cause to explain it. The interpreter is a natural pattern seeker and knows nothing of luck. This leads to numerous poor decisions. To manage the interpreter it is useful to know ahead of time how much luck determines results in an activity and to focus on one’s decision-making process in instances where luck is ample.
October 8, 2013
Research
Valuation
Credit Suisse
This report is a guide to estimating the weighted average cost of capital, with the goal of deriving a figure that is sensible from a business and economic standpoint.
September 17, 2013
Research
Markets
Credit Suisse
Most investors know about reversion to the mean and think that they take it into account as they model corporate performance, but in reality few deal with it properly. You can use the correlation coefficient to estimate the rate of reversion to the mean. High correlations imply slow reversion, and low correlations imply rapid reversion. To determine the mean to which results revert, consider the stability of the mean in the past as well as the factors that affect the mean.
July 22, 2013
Research
Competitive Advantage
Credit Suisse
Sustainable value creation has two dimensions—how much economic profit a company earns and how long it can earn excess returns. Both dimensions are of prime interest to investors and corporate executives. Sustainable value creation as the result solely of managerial skill is rare. Competitive forces drive returns toward the cost of capital. Investors should be careful about how much they pay for future value creation.
July 15, 2013
Research
Decisions
Credit Suisse
In investing, as in many other activities, the skill of investors is improving on an absolute basis but shrinking on a relative basis. As a consequence, the variance of excess returns has declined over time and luck has become more important than ever. Still, differential skill continues to exist. This process is called the paradox of skill. The key to generating excess returns is to not only be skillful but to find attractive “games”—situations where you can see where your excess returns are likely to come from. This report touched on three of those pockets of inefficiencies—diversity breakdowns, institutions versus individuals, and trading with investors who are buying for non-fundamental reasons—but there are undoubtedly more. The main lessons are that sometimes it’s more important to worry about the game you’re in than the skill you bring, and that you should always try to avoid being the patsy.
May 7, 2013
Research
Decisions
Credit Suisse
The goal of this report is to provide some tools and guidance to improve decisions on a day-to-day basis. Good judgment requires understanding causality, effectively incorporating information from past events to understand present prospects, and updating probabilities correctly based on the arrival of new information. We can all improve across each of these facets of decision making, but the fact is that few of us move past a functional and comfortable stage.
August 21, 2012
Research
Valuation
Legg Mason
The key to generating excess returns is the ability to distinguish between price and value—two very distinct concepts. The factors that create market inefficiencies are challenging for investors to deal with, making the mispricings difficult to exploit. The most basic question you must always answer: what’s priced in? This report walks through an expectations analysis for a large retailing company.
June 11, 2012
Research
Capital Allocation
Legg Mason
The prime responsibility of a management team is to invest financial, physical, and human capital at a rate in excess of the opportunity cost of capital. Executives should always seek to allocate capital to the opportunities with the highest returns. Buybacks can be more attractive than investing in the business. If the company of a stock that you own is buying back shares, you must recognize that doing nothing is doing something. The media must stop with the canard that investors deem buybacks to be good because they increase earnings per share (EPS)
March 23, 2012
Research
Markets
Legg Mason
Investing is fundamentally a bet on the future. The problem is that we only get to live once: we have to make choices in the face of uncertainty and deal with the consequences for better or worse. The mean-variance approach, the most common guide to build a portfolio, basically says that you should get the most return for a given level of risk based on the expected values of the individual assets and on how they correlate with one another. One of the great aspects of an affiliation with the Santa Fe Institute (SFI) is the opportunity to exchange ideas with world class scientists who are self-selected to be curious about the world. Ole Peters, trained as a physicist and a visiting researcher at SFI, is a great example. Ole has been discussing his concerns about the standard theories in economics for years, including portfolio theory, and he gave a talk last fall that prodded me to share his thoughts with a wider audience. At first, I considered writing about this myself. But then I figured it would be better to interview Ole and let you hear the story directly from him. Fair warning: this is not easy material. But I believe working through these ideas and their implications is time well spent.
February 24, 2012
Research
Markets
Legg Mason
There is a logical case for active management, but the key challenge is identifying above-average portfolio managers ahead of time. Most statistics in the investment industry and corporate America fail the dual test of reliability and validity. Active share and tracking error are both reliable statistics, and research shows that funds with high active share and moderate tracking error deliver excess returns on average. The long-term trend has been toward lower active share, which makes it difficult for mutual funds to generate sufficient gross returns to offset fees.
March 25, 2011
Research
Decisions
Legg Mason
Investors often make changes to their portfolios—with the best of intentions—that do not add value. These mistakes include reallocation of a portfolio from one asset class to another as well as switching from one manager to another within an asset class. Analysis through simulation shows that investors would be better off extending the industry standard three-year window for manager assessment.
January 12, 2010
Research
Capital Allocation
Legg Mason
Use economic, not accounting, measures to evaluate deals. While it stands to reason that executives seek to create shareholder value with the deals they do, the evidence shows that most don’t. It appears that executives (and investment bankers) miss the mark because they focus on accounting-based measures instead of considering the extent to which synergies can exceed the premium.
January 18, 2008
Research
Competitive Advantage
Legg Mason
In an efficient market, stock prices are an unbiased estimate of value. Market efficiency does not say that stock prices are always right; it only asserts that prices are not wrong in a systematic way. For this analysis, we combined our data on ROIC patterns with total shareholder returns to see whether there is a consistent way to generate excess returns.
December 20, 2007
Research
Markets
Legg Mason
Our focus here is on nonlinearity. Many complex systems, including markets, have critical points where small incremental condition changes lead to large-scale effects. Researchers in both the physical and social sciences have known about these critical points for a long time; so much so that terms like phase transition and tipping point have slipped into our day-to-day language. Still, critical points throw a monkey wrench into our mostly linear cause-and-effect thinking.
December 14, 2007
Research
Competitive Advantage
Legg Mason
This report seeks to shed light on an important reference class for company modelers: patterns of return on invested capital (ROIC). Companies create shareholder value when they generate returns on investment in excess of the cost of capital. A positive spread between a company’s ROIC and cost of capital is a fundamental indicator of value creation.
May 23, 2007
Research
Decisions
Legg Mason
What separates good from great investors is not knowledge or raw smarts, but patterns of behavior. All investors should be alert to black swans—events that are outliers, have an extreme impact, and are explained only after the fact. Cognitive errors, including loss aversion, are often the source of suboptimal investment decisions. Investors tend to underestimate the role of randomness in results.
March 20, 2007
Research
Decisions
Legg Mason
In this discussion, we apply Page’s models to three types of problems and provide real-world examples and data for a pair of them. Before moving into the analysis, three points bear emphasis: the importance of recognizing the problem type, the conditions under which the wisdom of crowds works, and why these ideas are so important for investors and decision makers.
January 16, 2007
Research
Decisions
Legg Mason
Simply stated, cognitive diversity produces a large tool set to solve complex problems. If your tools are no different than everyone else’s, you have no foundation for believing you can systematically outperform. We now turn to a handful of practical examples of how Santa Fe Institute-inspired thinking has offered insight into an investing problem.
September 30, 2006
Research
Valuation
Legg Mason
Investing relies on expectations, and revisions in expectations trigger changes in stock prices. Accurately measuring expectations, therefore, is the key to improving stock selection. Expectations investing requires (1) the development of a conceptual framework, (2) a clear understanding of valuation, including cash flow, the cost of capital, and the forecast horizon, and (3) accurate estimations of price-implied expectations and expectations gaps.
March 16, 2006
Research
Valuation
Legg Mason
DCF models should be economically sound and transparent. Economically sound means the company’s return and growth patterns are consistent with the company’s positioning and the ample empirical record supporting reversion to the mean. Transparent means you understand the economic implications of the method and assumptions you choose. Most DCF models fail to meet the standards of economic soundness and transparency.
February 1, 2006
Research
Decisions
Legg Mason
As an investor, maximizing wealth over time requires you to do two things: find situations where you have an analytical edge; and allocate the appropriate amount of capital when you do have an edge. While Wall Street dedicates a substantial percentage of time and effort trying to gain an edge, very few portfolio managers understand how to size their positions to maximize long-term wealth.
January 10, 2006
Research
Capital Allocation
Legg Mason
So what will American companies do with this excess cash? Simplistically, companies have two alternatives for deploying capital: invest via capital spending, working capital, mergers and acquisitions or return capital to the business owners through dividends and share buybacks. (See Exhibit 2.) While capital deployment is ultimately senior management’s most important task, many companies and investors fail to think clearly about how to best allocate capital systematically over the long term.
October 28, 2005
Research
Decisions
Legg Mason
This piece provides perspective on how to think about experts. We address some basic questions, including: What is an expert? What characteristics do experts share? Where do experts tend to do well and where do they do poorly? Does the world of investing have experts?
August 9, 2005
Research
Decisions
Legg Mason
In recent months researchers released two new papers with important implications for investors. The first paper adds insight into a classic social psychology study by using the latest functional magnetic resonance imaging (fMRI) technology. The second underscores the power of loss aversion by showing that certain brain-damaged subjects do better than healthy individuals in an investing game. We briefly review both studies and discuss their significance for the investment process.
July 27, 2005
Research
Competitive Advantage
Legg Mason
Remarkably, investors analyzing keystone companies often fail to recognize the significance of the ecosystem. By helping create and share value, keystone companies build a vibrant network that can innovate, adapt, and absorb substantial shocks. These features are at the core of sustainable competitive advantage.
May 20, 2005
Research
Markets
Legg Mason
If noise creates a set of expectations that are inconsistent with the long-term signal, there’s an opportunity for time arbitrage. Slow traveling ideas are a long-term investor’s best bet for delivering superior results.
April 11, 2005
Research
Markets
Legg Mason
This article addresses the question of how the market's efficiency arises. The central message is that managers can better understand markets as a complex adaptive system. Such systems start with a “heterogeneous” group of investors, whose interaction leads to “self-organization” into groups with different investment styles. In contrast to market efficiency, where “marginal” investors are all assumed to be rational and well-informed, the interaction of investors with different “decision rules” in a complex adaptive system creates a market that has properties and characteristics distinct from the individuals it comprises.
March 30, 2005
Research
Markets
Legg Mason
We offer a framework to understand market efficiency based on the theory of complex adaptive systems. The framework also offers insight into market inefficiency and how a long-term investor should try to take advantage of inefficiency. Along the way, we show how developments in standard finance theory, behavioral finance, experimental economics, and prediction markets fit into the complex adaptive system framework.
March 8, 2005
Research
Decisions
Legg Mason
There is no better lead in for the significant psychological constraints of contrarian investing. Without dwelling on the various sub-points, two major psychological requirements capture the idea: (1) independence (2) long-term orientation
January 14, 2005
Research
Valuation
Legg Mason
Price-earnings (P/E) multiples are by far the most popular valuation metric on Wall Street. A recent academic study found that 99.1 percent of analyst reports mention some sort of earnings multiple, and less than 13 percent provide any variation of a discounted cash flow model. 2 Still, most investors don’t have a clear sense of what a price-earnings multiple implies about a company’s future financial performance, or how a company’s price-earnings multiple will likely change over time.
December 9, 2004
Research
Competitive Advantage
Legg Mason
This report offers a framework to analyze businesses through the customer-value lens. In particular, we will cover four areas. First we discuss in detail the drivers of value per customer, including customer cash flows, loyalty, and acquisition costs. Next we look at ways to size the potential market. We then look at the issues in managing the current customer base. Finally, we point to some deficiencies in our accounting system for evaluating customer based businesses.
October 11, 2004
Research
Decisions
Legg Mason
This report focuses on how to categorize networks, how they affect economic value, and how they form.
August 5, 2004
Research
Decisions
Legg Mason
Statistical techniques clearly factor more prominently in the world of business and investing today than they did a generation ago. Perhaps sports analysis is just catching up to these other markets. But it is worth noting that there are some significant challenges in intelligently using statistics in sports, business and investing. These include: (1) predictions help shape the outcome (2) statistics are context dependent (3) the role of probability (4) the role of psychology (5) circumstance - versus attribute-based thinking
May 24, 2004
Research
Decisions
Legg Mason
We want to study the elite performers in probabilistic fields to see what traits they have in common. These traits will provide a guideline to assess skill versus luck in the investment business. In short, we need to look outside the investment business to understand skill within it.
February 24, 2004
Research
Decisions
Credit Suisse
In recent years, we have seen a blossoming in the number of surveys and channel checks, as well as other less savory information-gathering attempts. 3 While there is clearly nothing wrong with pursuing better information—and some firms do it very well—we question the investment value of much of today’s “proprietary” research. There are three sources of our skepticism. The first is whether or not investors can properly weight information. The second is sampling problems, or the degree to which the sampling techniques analysts use actually reflect the underlying population. The final issue is whether or not today’s proprietary research leads to superior investment performance.
February 10, 2004
Research
Competitive Advantage
Credit Suisse
Gaining a firm grasp of a company’s prospects for economic returns requires a thorough understanding of competitive strategy. The goal of strategic analysis is to address three fundamental questions: (1) Is the company generating returns on investment above the cost of capital, or is there good reason to believe it will earn attractive returns in the future? (2) If returns do exceed the cost of capital, for how long can the company sustain its excess returns? (3) Once a company’s returns dip below the cost of capital, what’s the probability it can stage a sustained recovery to above-required returns?
January 27, 2004
Research
Decisions
Credit Suisse
In Kahneman’s model, System 1 uses perception and intuition to generate impressions of objects. These impressions are involuntary, and an individual may not be able to verbalize them. He argues that System 2 is involved in all judgments, whether or not the individual is making decisions overtly. Intuition is a judgment that reflects an impression. Kahneman’s work (along with his collaborator Amos Tversky) shows how impressions can lead to judgments that are suboptimal according to classical economic theory. So the evidence suggests that you can’t separate emotions (System 1) from decisions (System 2). In fact, as Damasio showed, System 1 needs to operate normally in order for you to make good judgments. From an investor’s standpoint, two questions become central: What influences our impressions and how do these impressions shape perceptions of risk and reward?
January 13, 2004
Research
Decisions
Credit Suisse
The importance of embedded social context is relevant to investors on a number of levels. First, the more aware you are of your social surroundings, the better decisions you’ll make. Making sure that you seek and consider diverse viewpoints is one way to dilute the potentially negative consequences of context. Second, carefully consider social context when you assess the decisions of others. For example, corporate executives often fall prey to what Warren Buffett calls the “institutional imperative”; they follow the practices of the crowd, whether it be in mergers and acquisitions, compensation, or strategy.
December 16, 2003
Research
Competitive Advantage
Credit Suisse
Investors need to appreciate the innovation process for a couple of reasons. First, our overall level of material well-being relies heavily on innovation. Second, innovation lies at the root of creative destruction—the process by which new technologies and businesses supersede others. More rapid innovation means more success and failure for companies.
November 4, 2003
Research
Decisions
Credit Suisse
As we learn more about our brains, we may be able to alter our investment behavior individually so as to improve our results. As neuroscientist Antonio Damasio says, “You will be much more in control if you realize how much you are not in control.
November 2, 2003
Research
Capital Allocation
Credit Suisse
This is a short essay on our thoughts about management evaluation. We suggest three areas for careful consideration: management’s leadership, incentives, and capital allocation skills. We do not purport that this discussion is all encompassing—indeed, dedicated scholars have written countless articles and books on each of these topics. Our more modest goal is to stimulate thought in this vital, yet often overlooked, area.
October 21, 2003
Research
Decisions
Credit Suisse
Investors should take note of the accuracy of crowds for two reasons. First, information aggregation lies at the core of market efficiency. Here, we define efficiency as an inability for individuals to systematically exploit the market for superior returns. Second, companies that take advantage of the information embedded in collectives might be able to gain a competitive edge. We’ll describe a few companies that are trying to do just that.
October 7, 2003
Research
Decisions
Credit Suisse
A thoughtful investment process contemplates both probability and payoffs, and carefully considers where the consensus—as revealed by a price—may be wrong. Even though there are also some important features that make investing different than, say, a casino or the track, the basic idea is the same: you want the positive expected value on your side.
July 29, 2003
Research
Competitive Advantage
Credit Suisse
Our analysis suggests that distributions of the spread between returns on investment and cost of capital show self-affinity across five levels: country, industry, company, firm, and division... we believe these distributions present at least five concrete implications for investors
July 15, 2003
Research
Markets
Credit Suisse
Over a recent five-year period, the indexes outperformed about 70% of all active managers, and about three quarters of active funds underperformed the benchmark over 10 years. And this type of result has been consistent over time. Given how well the indexes have fared, it might be useful to provide a scouting report on how the indexes compete
July 1, 2003
Research
Markets
Credit Suisse
Corporate longevity is often, but not inevitably, incompatible with superior shareholder returns. We review the evidence supporting this view and offer a framework to explain a potential cause. The core idea behind this observation is not hard to express: Markets are more efficient at capturing the effects of creative destruction than companies are.
June 26, 2003
Research
Valuation
Credit Suisse
To gauge the quality of earnings, and the trend in earnings quality, we reconciled cash flow and operating earnings for all the companies in the Dow Jones Industrial Average (DJIA) for each of the past six years. The DJIA companies comprise about one-third of the market capitalization for the Standard & Poor’s 500 Composite Index. We define cash flow as the difference between cash flow from operations and capital expenditures.
June 17, 2003
Research
Markets
Credit Suisse
For investors, an understanding of why industries shift from vertical to horizontal is crucial because such shifts can lead to significant value migrations. Christensen’s work not only provides perspective on why industries have reconfigured in the past, but also offers a framework for anticipating such shifts.
June 3, 2003
Research
Markets
Credit Suisse
Why should investors care about cause and effect in the market? An appreciation of our need for explanation can be an inoculation against making mistakes. Investors who insist on “understanding” the causes for the market’s moves risk focusing on faulty causality, or inappropriately anchoring on false explanations. As we will see, many of the big moves in the market are not easy to explain.
May 20, 2003
Research
Decisions
Credit Suisse
In the investment world, we have a pretty good sense of what doesn’t work. Simple price-earnings-based valuation doesn’t work. High turnover portfolios rarely work because of the costs they incur. Relying on the same information sources as everyone else also doesn’t work. Yet many investment firms (buyside and sell-side) are like major league baseball teams—they either don’t take the time to consider alternative approaches or don’t have the fortitude to change. We should all take a page from the A’s book.
May 6, 2003
Research
Valuation
Credit Suisse
A look at Social Security’s evolution illustrates a crucial point: It is really hard to manage a system when the underlying data are constantly changing. You can’t draw conclusions from past averages, because they don’t accurately represent today’s averages. This lesson carries over directly to investing. One instance that stands out is when investors blithely apply historical average price-earnings ratios to value either today’s market or an individual stock. Past ratio averages are only applicable to the degree that they capture current circumstances. Just as no policymaker would dream of using old demographic data to assess the future of Social Security, investors should not casually rely on past price-earnings ratios to understand today’s market.
April 22, 2003
Research
Decisions
Credit Suisse
The main point here is not that humans are poor at relating probabilities to sequences of outcomes. The more important issue is that streaks inform us about probabilities. In human endeavors, unlike a fair coin toss, the probabilities of success or failure are not the same for each individual. Long success streaks happen to the most skillful in a field precisely because their general chance of success is higher than average.
April 8, 2003
Research
Decisions
Credit Suisse
We look at three systems that depend on collective behavior—social insects, decision markets, and the stock market—and consider the similarities and differences to gain better insights into how markets work. We conclude that collectives are very effective in a host of circumstances, but that there are substantive differences between these systems.
March 25, 2003
Research
Decisions
Credit Suisse
Why should investors care about the distinctions between risk and uncertainty? The main reason is that investing is fundamentally an exercise in probability. Every day, investors must translate investment opportunities into probabilities—indeed, this is an essential skill. So we need to think carefully about how we come up with probabilities for various situations and where the potential pitfalls lie.
March 11, 2003
Research
Decisions
Credit Suisse
There are two areas where competitive cooperation is especially valuable: pricing and capacity additions. We will use some basic ideas from game theory to show how cooperation can emerge and why it’s so hard to achieve. This tool is especially useful for industries where two competitors largely dictate industry actions.
February 25, 2003
Research
Decisions
Credit Suisse
Cialdini’s work over the past three decades has concentrated on what induces a specific form of behavior change: compliance with a request. Cialdini argues that six tendencies of human behavior spur a positive response to a request. All these tendencies are important to understand for life, and a few of them are particularly important for investors.
February 11, 2003
Research
Decisions
Credit Suisse
Expectations are embedded in all the decisions we make, especially investment decisions, but we rarely step back and consider how and why we form our expectations. Keynes guides this reflection. We will take a deeper look at two facets of expectations. The first distinguishes expectations built on deductive processes from those based on inductive processes: deductive processes reason from general premises to specific conclusions; inductive processes go from specific facts to general principles.
January 28, 2003
Research
Valuation
Credit Suisse
The St. Petersburg Paradox illuminates two very concrete ideas for investors. The first is that the distribution of stock market returns does not follow the pattern that standard finance theory assumes. This deviation from theory is important for risk management, market efficiency, and individual stock selection. The second idea relates to valuing growth stocks. What do you pay today for a business with a low probability of an extraordinarily high payoff? This question is more pressing than ever in a world with violent value migrations and increasing returns.
January 14, 2003
Research
Decisions
Credit Suisse
Much of investment theory is unsound because it is based on poor categorization. (We can say the same about management theory.) More specifically, investors generally dwell on attribute based categorizations (like low multiples) versus circumstance-based categorizations. A shift from attribute to circumstance-based thinking can be of great help to investors and managers. Here’s why.
January 9, 2003
Research
Markets
Credit Suisse
This is the time of year when strategists place their bets for the market’s return in the new year. A Wall Street Journal survey shows that the strategists, on average, expect about a 17% return in 2003.1 But a wide forecast range, from an anticipated 30% gain to a 9% drop, indicates a broad ecology of expectations. What’s the best way to think about the market’s likely return?
December 17, 2002
Research
Competitive Advantage
Credit Suisse
Researchers typically dedicate their efforts to either understanding how product markets develop or to how financial markets behave. However, discussion about how these two markets interact has been limited. We start by defining both markets and then discuss the four phases that “revolutions” go through. We then discuss what these revolutions mean for investors and total shareholder returns.
December 16, 2002
Research
Competitive Advantage
Credit Suisse
Industry analysis is the appropriate place to start an investigation into sustainable value creation. We recommend getting a lay of the land—understanding the players, a review of profit pools, and industry stability—followed by a five-forces analysis and an assessment of the likelihood of disruptive technologies. A clear understanding of how a company creates shareholder value is core to understanding sustainable value creation. We define three broad sources of added value: production advantages, consumer advantages, and external (i.e., government) advantages.
December 3, 2002
Research
Decisions
Credit Suisse
In recent years a new approach, naturalistic decision making, has emerged to explain how experts make decisions in real-world contexts that are meaningful and familiar to them. Evidence suggests that the key attributes and principles of naturalistic decision making apply to experienced investors. An understanding of naturalistic decision making may help investors better appreciate their own approach and has important implications for training.
November 19, 2002
Research
Decisions
Credit Suisse
We first define diversity, discuss why diversity is more important today than ever before, and point out how diversity actually improves problems solving. We then show how the MyersBriggs Type Indicator (MBTI), a tool that assesses personality types, provides a useful measure of diversity within an investment management firm. Finally, we explore how an understanding of how personality types differ within an organization can help manage the firm more effectively, improve communication between professionals, and guide resource allocation decisions.
November 5, 2002
Research
Competitive Advantage
Credit Suisse
The notion that managers should only focus on the long term is nonsensical. Have you ever heard of a company that blew 20 straight quarters but had a great 5 years? It doesn’t happen, because the long term is, by definition, an aggregation of short terms. So what’s the best way to think about managing for the long term in a complex environment?
October 22, 2002
Research
Competitive Advantage
Credit Suisse
Why should business people care about drosophila? A sound body of evidence now suggests that the average speed of evolution is accelerating in the business world. Just as scientists have learned a great deal about evolutionary change from fruit flies, investors can benefit from understanding the sources and implications of accelerated business evolution.
October 8, 2002
Research
Decisions
Credit Suisse
The issue is not whether or not individuals are irrational (they are), but whether or not they are irrational in the same way at the same time. We argue that while understanding individual behavioral pitfalls may improve your own decision-making, appreciation of the dynamics of the collective is key to outperforming the market. Behavioral finance enthusiasts often fail to distinguish between the individual and the collective.
September 26, 2002
Research
Capital Allocation
Credit Suisse
We believe that the FASB will mandate expensing employee stock options by 2004. Over 100 companies have announced their intention to voluntarily expenses options, although most large options users are conspicuously absent from the list. We analyzed the stock price impact of those companies that have announced that they will voluntarily expense options. Our analysis shows that the mean and median change in stock price was very close to zero for the one-, two-, and three-day period subsequent to the announcement. This suggests that markets already reflect the impact of options in value.
September 24, 2002
Research
Markets
Credit Suisse
Why should investors care about power laws? First, the existence of power law distributions can help reorient our understanding of risk. Most of finance theory—including models of risk— is based on the idea of normal or lognormal distributions of stock price changes. A power law distribution suggests periodic, albeit infrequent, price movements that are much larger than the theory predicts. This fat-tail phenomenon is important for portfolio construction and leverage.
September 10, 2002
Research
Decisions
Credit Suisse
Why should investors and businesspeople care about neural development? Neural overproduction and subsequent pruning appears to parallel closely with what happens when a new industry emerges. An understanding of this process provides investors with three benefits. First is a model of innovation that is both theoretically sound and that researchers have tested empirically. Second, investors have a basis for understanding manias or bubbles. Finally, it shows that the innovation process typically leads to investment opportunity.
August 7, 2002
Research
Valuation
Credit Suisse
High-profile scandals have caused investors to cast a critical eye on financial statements. In an effort to gauge the quality of earnings and the trend in earnings quality, we reconciled earnings and cash flow for all the companies that constitute the Dow Jones Industrial Average (DJIA) for each of the past five years. Our analysis shows that cash flow was 96% of operating net income on a weighted basis for the DJIA companies in 2001, the highest ratio in the past five years. We also discuss the accounting for pensions and employee stock options. Most of the public dialogue surrounding these items has been inane. We focus on the economics of pensions and options
July 18, 2002
Research
Capital Allocation
Credit Suisse
At year-end fiscal 2002, the company had about $53 billion in cash, short-term investments, and equity investments. Microsoft’s cash balance alone is sufficient to make it one of the top 35 companies in the S&P 500 by market capitalization. Given issues with taxes, shareholder flexibility, and employee stock options, we believe that dividends are a suboptimal way to return cash to shareholders for Microsoft. Share buybacks make much more sense. We estimate that the expected rate of return on a share-buyback program is 14.5%, well in excess of the returns MSFT earns on its cash. We believe that the company can return $28 billion to shareholders while supporting its long-term growth plans.
July 16, 2002
Research
Markets
Credit Suisse
The stock market, like the bond market, is a discounting machine. This means that under “normal” conditions, investors should expect a mid- to high-single-digit nominal return over time. Sentiment swings, extreme optimism or pessimism, can distort these expected returns. (When investors expect returns to be highest is when they’re likely to be the lowest, and vice versa.) In these difficult markets such as we have today, investors are well served to try to maintain perspective and avoid groupthink. In particular, reflecting on history and carefully considering multiple scenarios can be helpful to provide necessary calibration. Buffett, with an emphasis on how easy it is to get swept up in emotion and a dismissal of overly quantitative approaches, comments: ...an investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the supercontagious emotions that swirl about in the marketplace.
July 2, 2002
Research
Decisions
Credit Suisse
Why should investors care about memes? There are two reasons. First, an understanding of cultural evolution provides crucial insights into the process of change. Second, a heightened awareness of how ideas get into our minds allows us to become better meme managers. Understanding change and managing our minds are critical to successful stock picking.
June 30, 2002
Resesearch
Valuation
Credit Suisse
A number of investors, seeking to revisit their investment process, asked us to discuss the widely used valuation tools that have significant shortcomings and to explain why the measures are misleading. The current challenging market environment provides an opportunity to revisit and reshape valuation memes.
June 21, 2002
Research
Competitive Advantage
Credit Suisse
We explore the ways loyalty creates value. Companies that enjoy significant customer loyalty tend to be more valuable than those that do not. Analysis of customer net present value shows why reports of total customers, or net customer additions, are incomplete. In some industries, a 500-basis-point increase in retention rates can almost double customer net present value.
June 18, 2002
Research
Markets
Credit Suisse
Why should investors care about the janitor’s dream? If the stock market is a system that emerges from the interaction of many different investors then reductionism—understanding individuals—does not give a good picture of how the market works. Investors and corporate executives who pay too much attention to individuals are trying to understand markets at the wrong level. An inappropriate perspective of the market can lead to poor judgments and value-destroying decisions.
June 5, 2002
Research
Capital Allocation
Credit Suisse
The raging debate about the role and treatment of employee stock options (ESOs) remains at a fever pitch. Politicians, executives, accountants, and economists are all weighing in with their view. Unfortunately, in many cases common sense and empirical evidence suffer as these pundits forward their myriad, and sometimes conflicting, interests. It’s time to step back and take a fresh look at ESOs.
June 4, 2002
Research
Decisions
Credit Suisse
"Knowin’ the 60-40 end of a proposition, money management, and knowin’ yourself.” For good measure, Pearson added, “Any donkey knows that.” 1 Pearson’s message may be colloquial, but that in no way undermines its power. We can express the ideas more formally, and readily draw out critical investment concepts. Taken together, Pearson’s points indeed provide a strong foundation for investment success.
May 21, 2002
Research
Markets
Credit Suisse
When is positive feedback good? Well, it can help promote a smart decision. For instance, early investors in a promising new industry may encourage others to invest, sparking the industry’s growth. Positive feedback can also get a system out of a bad situation. In nature, a “follow-your-neighbor” strategy may allow a flock of birds to elude a predator. Analogously, it can help investors flee a bad investment.
May 7, 2002
Research
Decisions
Credit Suisse
Of particular importance for money managers, stress encourages a short-term focus. Recent research shows that people (like other animals) often prefer small, immediate rewards to larger rewards in the future. For example, people prefer one apple today over two apples tomorrow. But if the trade-off is far enough in the future—for example, one apple in a year versus two apples in a year and a day—people are prepared to wait for the higher reward. Seeking short-term gains at the expense of more attractive long-term rewards is suboptimal for long-term investors.
April 23, 2002
Research
Valuation
Credit Suisse
Investors and managers must have reasonable expectations. The evidence shows that sustaining rapid growth is very difficult, especially for large corporations. Further, while there is nothing wrong with growth stocks, the indications are that it is very difficult to know which companies will exceed expectations and which will disappoint. Investors should continue to focus on investment ideas where the expected value is favorable— where the upside opportunity outstrips the downside risk.
April 15, 2002
Research
Capital Allocation
Credit Suisse
We argue that dividends are in the final stages of long-term demise. Dividends and share buybacks are theoretically equivalent means to return cash to shareholders, but buybacks are more tax efficient. Evidence from the recent past and prevailing factors suggest that dividends will lose ground to share buybacks.
April 9, 2002
Research
Markets
Credit Suisse
A useful means to navigate a fat-tailed world is to first measure the current expectations underlying an asset price, and then contemplate various ranges of value outcomes and their associated probabilities. This process allows investors to give some weight to potential fat tail events. Standard finance theory has advanced our understanding of markets immensely. But some of the theory’s foundational assumptions are not borne out by market facts. Investors must be aware of the discrepancies between the theory and reality and adjust their thinking (and portfolios) accordingly.
March 26, 2002
Research
Decisions
Credit Suisse
Our focus here is on the micro level or how investors, as individuals, should organize for investment success. While the unit of analysis is different, the message is the same: diverse information and perspectives can help improve investment performance
March 14, 2002
Research
Capital Allocation
Credit Suisse
We conducted a study of the 39 largest U.S. M&A transactions in 2001. The relationship between the magnitude of the premium and the anticipated synergies is a strong predictor of the market’s initial reaction to a deal. Two-thirds of deals were followed by a negative stock reaction for acquiring company shareholders. While the majority of the deals were all-equity, shareholders reacted more favorably to cash deals. The anticipated EPS impact had no measurable bearing on the market’s reaction to deals.
March 12, 2002
Research
Markets
Credit Suisse
The coexistence of market stability and company-level instability may seem like a paradox, but it has substantial significance for investors—both in equities and fixed income. In particular, it has implications for diversification strategies, proper assessment of debt/equity ratios, and importance of the creative destruction process. We explore these issues in more detail below.
February 26, 2002
Research
Competitive Advantage
Credit Suisse
How does thinking about leader/challenger dynamics help investors? These dynamics are not only a mental model for innovation, but are also useful because there appears to be a discernable pattern of investor reaction to innovation. Investors tend to understate and overstate growth prospects.
February 12, 2002
Research
Competitive Advantage
Credit Suisse
What does a fitness landscape look like? Envision a large grid, with each point representing a different strategy that a species (or a company) can pursue. Further imagine that the height of each point depicts fitness. Peaks represent high fitness, and valleys represent low fitness. From a company’s perspective, fitness equals value-creation potential. Each company operates in a landscape full of high-return peaks and value-destructive valleys. The topology of the landscape depends on the industry characteristics.
January 29, 2002
Research
Decisions
Credit Suisse
Building a portfolio that can deliver superior performance requires that you evaluate each investment using expected value analysis. What is striking is that the leading thinkers across varied fields—including horse betting, casino gambling, and investing—all emphasize the same point. We call it the Babe Ruth effect: even though Ruth struck out a lot, he was one of baseball’s greatest hitters.
January 15, 2002
Research
Decisions
Credit Suisse
The Consilient Observer seeks to link market-based facts to mental models from various disciplines to help investors make better decisions. Consilience, a book by biologist E.O. Wilson, serves as the inspiration for our title. Consilience literally means the “jumping together” of knowledge. Wilson argues that knowledge across diverse disciplines— physics, biology, economics, and the arts, for instance—can be unified at a fundamental level. Indeed, one has to think across disciplines to deepen his or her understanding of the world.
January 15, 2002
Research
Competitive Advantage
Credit Suisse
How does a company get off of the fast-growth and low-return treadmill gracefully? A company can either slow its growth, increase its economic returns on future investment, or do both. It appears that growth was endemic to the Enron culture, a perspective that was fanned by ambitious internal growth goals and lofty expectations from the financial community. Slowing growth seemed the go against Enron’s grain, especially given all that was riding on Enron’s stock price performance.
October 4, 2001
Research
Competitive Advantage
Credit Suisse
We believe the concept of competitive advantage period, or CAP, plays a major role in bridging the gap between finance and strategy. CAP indicates how long the market expects a company to create shareholder value. Equivalently, investors can express CAP as the number of years the market expects a company to generate excess returns—returns above the cost of capital—on new investments.1 Economic theory, borne out daily in the markets, predicts that high-return businesses will attract investment from competitors, inevitably driving their returns lower. The inverse is true for low-return businesses.
September 24, 2001
Research
Capital Allocation
Credit Suisse
Microsoft is undoubtedly one of the most formidable companies in the world. The point of this report, however, is not to opine on Microsoft as an investment, but rather to review Microsoft’s fiscal 2001 10-K as a great study in financial statement analysis. If nothing else, Microsoft’s financial statements show why it is so potentially misleading to look solely at income statements.
September 24, 2001
Research
Capital Allocation
Credit Suisse
Share buyback announcements have surged following the tragedy earlier this month. Since September 12, there have been in excess of 225 share buyback announcements with an aggregate value of about $30 billion, versus only about a dozen in the eight days prior to the event (see Exhibit 1 for a breakdown by sector). Spurred by lower stocks prices, relaxed SEC regulations, and patriotism, companies are stepping up in the midst of uncertainty. The sharp acceleration in announcements begs an important question: will these buybacks create shareholder value?
August 3, 2001
Research
Markets
Credit Suisse
Investors should base the magnitude of their investments on the size of the margin of safety. For companies with variable outcomes, the consensus can be the most likely outcome and the stock may still be attractive or unattractive. Companies with narrow outcomes require a non-consensus point of view in order to determine whether to buy or sell the stock.
August 2, 2001
Research
Valuation
Credit Suisse
This report is broken into four parts. First, we have outlined a practical framework for analyzing the cash economics of business models. Second, we have introduced a graphical way of highlighting differences between business models—the cash economics matrix—and apply this framework to compare companies. Third, we generalized from our case studies to outline a cash economics lifecycle for companies. Finally, since the market values a company’s ability to generate cash, we have used this cash economics analysis to explain one possible source of the continuing high valuations of some knowledge companies.
August 1, 2001
Research
Valuation
Credit Suisse
In this report, we identify some frameworks that can help investors understand the valuations and expectations—especially in certain sectors of technology. We first explain why the replacement cycle is more important than ever. We then show a three- stage model of technology diffusion and show the relevance (graphically and numerically) of shifting replacement cycles. We finish with a case study of the wireless handset industry, and show the impact a various replacement cycle assumptions on the near-term growth outlook.
June 11, 2001
Research
Markets
Credit Suisse
In this report, we introduce market-expected return on investment (MEROI) as an important complement to the expectations investing toolkit. MEROI provides a good sense of where the rate of return performance bar is set.
June 1, 2001
Research
Valuation
Credit Suisse
It is important to clearly understand the distinction between price and value. Price reflects the collective expectations of investors. Value, if it is to be logically distinct from price, implies that an investor believes something different than what the market believes. In order for investors to have a firm grasp on where and why their views are different than the market, it is important that they understand where the market stands.
April 6, 2001
Research
Markets
Credit Suisse
The rise and fall of Internet stocks has created enormous fervor. But the fundamental question at hand is a simple one: what should investors do today? We should note at the outset that the Internet is a general-purpose, or enabling technology. The Internet is not a substitute for a business model, and does not constitute a strategy in and of itself. Still, the boom/bust of the Internet is by no means a unique phenomenon—we can document the same pattern in the history of the evolution of both biological species and American business.
March 5, 2001
Research
Markets
Credit Suisse
Since the end of November, earnings estimates (based on our internal estimates) for the Nasdaq 100 in 2001 have been trimmed an additional 6%, following a substantial 8% decline from March 2000 and November 2000. Expectations for future earnings growth rates have dropped to 16.1% currently, well below the 18.5% rate implied by the November composite and the over-21% rate in March 2000. This is by far the most important driver of value. We estimate that over 50% of the Nasdaq’s three- and 12-month decline stems from this moderation.
February 20, 2001
Research
Competitive Advantage
Credit Suisse
First, we explore the economics of value creation in some detail. Here, we clearly establish the drivers of shareholder value, which should be the unrelenting focus of managers and investors alike. Second, we discuss business category evolution. The main idea here is that various business categories—physical, service, and knowledge—have different properties and characteristics. Both managers and investors have to understand the challenges and opportunities of category migration. Third, we discuss what is probably the toughest part of the transition—the required mindset shift. In our discussions with literally dozens of management teams, we find that executives are intellectually prepared to embrace change, but are not organizationally prepared to do so. We wrap up with a discussion of how to measure a company’s progress.
December 12, 2000
Research
Competitive Advantage
Credit Suisse
We suggest that investors consider three actions in response to this innovation. First, it is important to be wary of current market leaders, especially those with sizable market capitalizations. These companies are often the most vulnerable to future innovation. Second, find the future. Isolate those companies that represent the next generation. Finally, avoid innovation risk all together by playing industries that are sheltered from change.
December 1, 2000
Research
Markets
Credit Suisse
The Nasdaq is down about 40% since the end of March, leaving investors wondering what has happened and where we are going. We believe our proprietary valuation work offers unique insight into market expectations. Understanding current expectations, and the revisions in those expectations over the past 8 months, provides investors with the necessary calibration to make forward-looking investment decisions
September 17, 2000
Research
Markets
Credit Suisse
Investors cannot rely on old tools and techniques to give them an edge in today’s investment environment. As we transition to an economy where knowledge replaces physical capital as the fundamental driver of value, investors must consider the human face of technology. Market leaders shape the development of their markets. Against the backdrop of constant change it becomes more important than ever to follow the strategic progress of bellwether firms.
September 11, 2000
Research
Markets
Credit Suisse
Growing evidence accumulated from market models of heterogeneous agents should prompt investors to approach the dated market efficiency debate with a fresh perspective. Recognizing the trading features associated with a financial ecology breakdown can lead to profit opportunities.
July 7, 2000
Research
Competitive Advantage
Credit Suisse
We first explored power laws and the Internet in late 1999.4 Despite a sharp correction in Internet stock prices over the last six months, the relationship between rank and the market value of online firms is still best expressed with a power law. This winner-take-all distribution continues to support the notion that competition on the Web has unique characteristics. Not only can large firms grow as quickly as small firms, but the positive-reinforcing nature of the medium also translates into a source of sustainable competitive advantage. This report explores some of the factors that may contribute to the observed distribution.
May 11, 2000
Research
Competitive Advantage
Credit Suisse
How did Yahoo! blossom to a $70 billion company with over 120 million users in just five years? Why is Sabre, an Internet travel and reservations company, awarded a market value that currently exceeds the combined market capitalization of three prominent airlines? And why do some business-to-business hubs have valuations that exceed the entire productive output of their respective vertical industries? The goal of this report is to answer these questions. We address the issue in three parts. First, we explore some basic network dynamics, including the concept of network effects and where they are most prominent. Second, we discuss networks and economic value, touching on the sources of value creation, the economic characteristics of networks, and how they serve as a source of sustainable competitive advantage. Finally, we study the key issue of network formation in an attempt to understand how and why certain networks emerge as dominant.
February 4, 2000
Research
Valuation
Credit Suisse
This report lays out a case for looking beyond ubiquitous earnings-based metrics. Further, it provides a transparent framework, highlighting the difference between accounting convention and economic reality.
December 20, 1999
Research
Competitive Advantage
Credit Suisse
Despite being convinced of the disruptive nature of the online medium, we believe that value creation for most Internet companies will be restricted due to the difficulty of achieving sufficient scale. This begs some important questions. Who has the advantage in achieving this scale? Does the Internet, as a self-organizing system, have any interesting—or unexpected—characteristics?
December 10, 1999
Research
Decisions
Credit Suisse
In this article, we build on four themes: revolutionary economic shifts, decentralization, globalization, and bits over atoms. There is one common and powerful thread linking each theme: the speed and increasing ubiquity of information technology. Information technology is changing many of the rules of the game, both for companies and investors. This is not to say the laws of financial economics have changed. It does suggest, however, that mental models must be updated.
November 22, 1999
Research
Capital Allocation
Credit Suisse
This report is broken into four parts. First, we explore the shift from atoms to bits. Our analysis reveals clear evidence of a surge in intellectual capital that is not well captured in aggregate data. Second, we highlight the cash conversion cycle as a useful starting point in identifying companies that are successfully replacing tangible assets with intellectual capital. Third, we apply the cash conversion cycle to various sectors and companies. This analysis highlights shifts in the economy and provides critical insights about valuation. Finally, we show how the cash conversion cycle can be a great tool for stock picking
October 25, 1999
Research
Competitive Advantage
Credit Suisse
Traditional retailers are facing a menacing challenge from a new value network, the online medium, which has emerged as a result of demonstrable improvements in economic efficiency and customer satisfaction. Many investors and incumbents view the Internet as a sustaining technology that merely adds another node of distribution to the traditional retail operation. We prefer to view online retail as a disruptive technology. Retailers underestimate the magnitude of the difficulties in assembling a credible online offering. The chief barriers revolve around culture and physical capital.
June 23, 1999
Research
Valuation
Credit Suisse
Real options are particularly important for businesses with a few key characteristics. The first is smart and reputable management with access to capital. Managers must understand options, identify and create them, and appropriately exercise them. This contrasts with business leaders focused on maintaining the status quo or maximizing near-term accounting earnings. Businesses that are market leaders are also attractive, as they often have the best information flow and richest opportunities—often linked to economies of scale and scope. Finally, real options are most applicable precisely where change is most evident.
March 11, 1999
Research
Competitive Advantage
Credit Suisse
We define four barriers to entry that may serve as the source of sustainable competitive advantage in the New Economy. These advantages will not accrue to all companies, but will allow a select group to generate outsized earnings power.
March 2, 1999
Research
Valuation
Credit Suisse
This report is broken into four parts. First, we have outlined a practical framework for analyzing the cash economics of business models. Second, we have introduced a graphical way of highlighting differences between business models—the cash economics matrix—and apply this framework to compare Old and New Economy companies. Third, we generalized from our case studies to outline a cash economics lifecycle for typical Old and New Economy companies. Finally, since the market values a company’s ability to generate cash, we have used this cash economics analysis to explain one possible source of the relatively high valuations of New Economy companies.
February 2, 1999
Research
Markets
Credit Suisse
This report has three parts. First, we document the trend in the market-weighted return on invested capital for the S&P industrials, and show how and why market multiples are less-and-less indicative of economic reality. Second, we discuss the emergence of a “fat tail”—a bump on the right hand side of a market-wide ROIC distribution. It is this fat tail that is skewing both the performance of the indices and index-based valuation comparisons. Finally, we explore the composition shift in the S&P 500, and speculate about what that shift means for money managers.
January 26, 1999
Research
Valuation
Credit Suisse
The goal of this report is not to defend valuations in the marketplace. Rather, it is to offer some counterweight to the argument that current market values are completely unfounded. Indeed, we believe that some of the key value drivers in technology are not obvious and are, in some cases, counterintuitive.
December 11, 1998
Research
Markets
Credit Suisse
This report is broken into three parts. First, we look at potential explanations for the difference between individual and aggregate behavior in markets. Next, we explore complex adaptive systems as a way to understand markets. Finally, we suggest using market signal analysis as a practical outcome of our analysis.
November 18, 1998
Research
Decisions
Credit Suisse
The goal of this report is to lay out mental models for understanding businesses in the new economy. In many cases the new models are radical departures from the current strategy dogma and their relevance is growing rapidly as the world be-comes increasingly digitized. We believe that all investors—not just those involved with high technology—will need to understand the new ground rules if they are to outperform the market.
October 29, 1998
Research
Capital Allocation
Credit Suisse
In this report we present a comprehensive framework for analyzing employeestock option (ESO) programs. While ESOs have been the subject of a great dealof commentary, economic rigor has been absent in many of these discussions.We present what we believe is the most in-depth, financially sound, and usabledescription of ESOs to date.
September 29, 1998
Research
Competitive Advantage
Credit Suisse
This report explores how competitive advantage, strategy and capital market valuation are intertwined. It is broken into three parts. First, we define key terms. Second, we explore the empirical return on invested capital data. Finally, we link the financial metrics to the workings of the stock market.
August 7, 1998
Research
Capital Allocation
Credit Suisse
The issue of share repurchase is more relevant, and more complex, than ever. On the one hand, strong corporate surplus cash flows, favorable tax laws and an increasing focus on shareholder value encourage managers to embrace buybacks. On the other hand, high price/earnings multiples, the surge of employee stock option programs and the desire for internal growth make the virtues of repurchases less clear.
October 24, 1997
Research
Markets
Credit Suisse
First, we provide a description of complex adaptive systems, identifying key properties and attributes. Next, we compare the results predicted by the new theory to actual market behavior. Finally, we check for correspondence.
October 21, 1997
Research
Valuation
Credit Suisse
My objective today is to walk through, very logically, why we think value-based analysis is a powerful tool for both investors and the corporations. We’ll approach the issue in three different ways. First, we’ll talk about stock market myths and stock market reality. Next, we will evaluate valuation techniques, weighing the pluses and minuses of each. Finally, we will lay out the case for a value-based model.
March 12, 1997
Research
Decisions
Credit Suisse
The process of investing money successfully in capital markets is not something that most humans are designed to do— at least yet. An evolutionary perspective shows that we are attempting to deal with a relatively new set of problems (what’s the expected return of this asset?) with an old set of tools (let’s run from danger). The best antidote to this dichotomy is to be as self-aware as possible— mindful of handed-down emotional limitations— and to stress personal strengths at the expense of personal weaknesses.
January 14, 1997
Research
Competitive Advantage
Credit Suisse
The focus must be on the economic drivers of a business, which can be defined as cash flow (cash-in versus cash-out), risk (and appropriate demanded return) and what we have dubbed “competitive advantage period”— CAP— or how long returns above the cost of capital will be earned. CAP is also known as “value growth duration” and “T” in the economic literature. CAP is also similar in concept to “fade rate.”