3 Ways You can Find Out Market Expectations of a Stock


I’ve recently been putting more weight to the question of “What are the expectations for this stock?”.

Rather than purely concentrating on a bottom up approach where I value the assets, cash flow and growth to come up with a range of intrinsic values, questioning what the markets expects out of the stock adds another dimension to the valuation process.


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Jae Jun

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I’ve recently been putting more weight to the question of “What the market expectations of a stock?”.

Rather than purely concentrating on a bottom up approach where I value the assets, cash flow and growth to come up with a range of intrinsic values, questioning what the markets expects out of the stock adds another dimension to the valuation process.

Market Expectations of a Stock Using Valuation Methods

market expectations of a stock

Market expectations of a stock

Market Expectations of a Stock Based on Historical Data

When performing any stock valuation, you are extrapolating numbers based on historical data.

e.g. DCF could come out to $40, Graham’s formula shows the stock to be worth $65 and EPV gives a conservative $30.

Which one is correct? Can you assume that the range is $30 – $65 and invest in the company comfortably?

By figuring out what the expectations are, you can take it one step further. In other words, invert the valuation.

Understand What the Crowd is Saying

In Mauboussin’s book More than You Know, he writes of an experiment that was played out in a university  classroom. The professor has a large jar of jelly beans and asks a student to guess how many jelly beans were contained in that jar.

The first student gives an answer way off the mark.

The professor repeats this process for each student in the room.

At the end, not one student got the correct answer. The range of values were high, with many incorrect answers.

However, the average of all the answers turned out to be the closet to the jelly bean count.

The market works like this. More so the market expectations of a stock. You have millions of individuals offering differing opinions. Value investors will provide conservative estimates, growth investors will provides extreme estimates. No single person may be correct, but over time, the value will be recognized by the market.

I’m not putting forth an argument that the market is efficient. My point is that understanding how the market thinks about the stock is important. Does Mr Market know more than you or does he know less?

Reverse Engineering Valuation Methods

The additional questions you should now be asking  yourself are the following:

1) What is this stock worth?

2) What is this stock NOT worth?

And here are a few methods of how to go about answering these questions the inverse way.

Reverse DCF

A reverse DCF valuation will help you find the expected growth rate the market is pricing in.

Set the discount rate to something that is reasonable. For small caps, a discount rate of 12-15% is desired. For large caps, 9% discount rate is satisfactory.

However, an easy way to find your desirable discount rate is:

Discount rate = Risk Free Rate + Risk Premium

Asset Valuation

Use this simple equation to see what the expectations are.

stock price = assets + expectations (a.k.a growth or speculative value)

If the stock price is made up of a lot of assets, not much growth is expected. If the company can either perform at the GDP rate (around 4-5%) then you have a good chance of finding a winner.

If the stock price is made up of little assets, there is a likely chance that the company will disappoint in the near future.

Reverse Earnings Valuation

This reverse earnings power value next one is more complex and based off expected earnings power. Think of it as a reverse EPV.

1. Create your multiple

2. Calculate Excess Cash of interest bearing debt into a per share price

3. Deduct Excess Cash per share price from the current market price of the stock

4. Divide remaining amount by the multiple in step 1

5. Determine a proper earnings growth rate or use an analysts assumption to draw ideas on (don’t rely on the analysts information – just use it to see what information you can derive from it)

6. Find how long it would take to grow shares from what they are currently to what Step 4 produced using the assumed growth rate

7. Determine in your own mind using logic and rationality how feasible the proposition is based on the information at hand

Invert the Problem to See What the Market Expects

There are other ways of reverse valuation to determine the market expectations of a stock, which I’ll walk you through another time, but one thing that becomes clear is that once you start doing this, your questioning and thought process starts to change.

  • Jon

    Jae,

    Just found your blog from a link list of valuewalk.com.

    I was looking at some of your older entries which included some of the holdings you have 50% of your money in and I did a little bit of research on a few of them including Dacha.

    One thing I found weird that maybe you could shed some light on:

    Address: 65 Queen Street West, Suite 800, Toronto, ONT M5H 2M5
    Phone: 416 – 861- 5903
    CEO: Scott Moore
    CFO: Brad Boland

    Athlone Global Security(I-Banking and Securities)
    Address: 65 QUEEN ST W SUITE 815
    Toronto, Ontario M5H 2M5
    Phone: ***416 – 861 – 5903***

    Corporation Ressources Franc-Or(Site Preparation Contractors)
    Address: 65 QUEEN ST W SUITE 805
    Toronto, Ontario M5H 2M5
    Phone: ***416 – 861 – 5903***
    President: ***Scott Moore***

    Crocodile Gold Corp
    Address: 65 Queen St. West, Ste. 815
    Toronto, Ontario M5H 2M5
    Phone: ***416 – 861 – 5903***

    Sulliden Gold Corp
    Address: ***65 Queen Street W, Suite 800, Toronto, ON M5H 2M5***
    Phone: ***416 – 861 – 5903***
    Vice President: ***Scott Moore***

    One more weird thing. Type in the address on google maps so that it centers on the area, then type in Dacha and you wont even get a result. You will for Sulliden for example, but not Dacha. I thought this was a company with $120 million in metal investments? How do you not even show up on google maps?

    Maybe there is a good explanation to all of this, but in case this is news to you I thought I would at least post it on here.

  • Hi Jon,

    If you go through their reports, you will see that they share their office with other companies.
    Their inventory is all located overseas so they don’t need a big presence in Canada.

  • Jon

    And they share their phone number and their chief executive as well?

  • All of the companies were started and funded by Manahattan and Forbes group where Scott Moore and Stan Bharti are deeply involved.

    Note that Scott Moore is not the CEO of the companies. He is a “president”, which could mean many things unless it’s a huge company, or a board of director.

  • Jon

    Okay good answer.

    When it comes to the pink sheets would you agree that the first concern of an investor is the ability to believe the financial statements, news, etc. coming out of the firm before anything else?

    Given that their financial statements are unaudited how certain are you that their actual operations are accurately reflected in their disclosures? I put up those questions to glean whether or not the company just popped out of a stock screener you ran or if you actually have researched enough to be able to verify a lot of its business. Its looking more like the latter in your answers, but maybe you could elaborate some more, and how you went about trying to verify the operations.

  • Remember that pink sheets also contain high quality companies. See below link.
    http://www.oldschoolvalue.com/blog/investing-perspective/gambling-speculating-pink-sheets/

    Here is the article I wrote that goes into detail about Dacha. Better to continue the conversation over there rather than in the comments of an unrelated topic.
    http://www.oldschoolvalue.com/blog/stock-analysis/on-sale-40-off-my-highest-conviction-pick/
    http://www.oldschoolvalue.com/blog/forum/d-stocks/dacha-strategic-metals-dchaf-dsm/

  • Jae,

    Great article. Just kind of a side not here. I know you’re a reader of Joe Ponzio. What do you think of his attitude toward picking a discount rate and sticking to it? He suggests to only mess with the Margin of Safety. I have always kind of gone with his approach and picking a discount rate based on my desired satisfactory return and then adjusting the margin of safety to the risk level of the stock. Do you adjust the discount rate and the margin of safety? Or do you just adjust the discount rate to suite your analysis?

  • Jon

    Alright I wasn’t sure that you would even respond to some of the older articles so I wrote in this one.

    So you’ll find me in the first one you linked: gambling speculative pink sheets.

  • @Daniel,
    Always a difficult task but I prefer to keep it simple. At the moment, it’s just easier to demand a return that is above the risk free rate but not way over the top and unrealistic.

    I never adjust the discount rate to suit my analysis. That would just be manipulating the numbers to suit me. It’s a fine art really. This is a topic that I am currently discussing in the forum.
    http://www.oldschoolvalue.com/blog/forum/value-investing/bond-yields-and-your-margin-of-safety/

  • Hi Jae.I would like to ask you ( in reverse earning valuation, what do you mean by “create your multiple?” or should I say which multiple are you referring to?
    One more thing. The benjamin number is a mystery to me in regards to the p/e. The p/e is supposed to be a no growth stock but, if the stock was a no growth why would you use a p/e of 8?
    Another mystery is I have about a dozen or more ways to value a stock and many times what should be an appreciation it comes out flat or a small appreciation because the mystery box is trying to understand the sentiment of the crowd and rarely the numbers.
    One of my valuation method is taking the forward eps plus growth times current p/e/ 1.15
    The other is forward eps times growth

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