VALUE,PRICEANDINFORMATION:CLOSINGTHEDEAL

ValueversusPrice

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Areyouvaluingorpricing?

INTRINSIC VALUE PRICEValue Price

THE GAPIs there one?Will it close?

Drivers of intrinsic value- Cashflows from existing assets- Growth in cash flows- Quality of Growth

Drivers of price- Market moods & momentum- Surface stories about fundamentals

Tools for pricing- Multiples and comparables- Charting and technical indicators- Pseudo DCF

Tools for intrinsic analysis- Discounted Cashflow Valuation (DCF)- Intrinsic multiples- Book value based approaches- Excess Return Models

Tools for "the gap"- Behavioral finance- Price catalysts

Drivers of "the gap"- Information- Liquidity- Corporate governance

Value of cashflows, adjusted for time

and risk

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Test1:Areyoupricingorvaluing?

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Test2:Areyoupricingorvaluing?

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Thedriversofvalue

What are the cashflows from existing assets?- Equity: Cashflows after debt payments- Firm: Cashflows before debt payments

What is the value added by growth assets?Equity: Growth in equity earnings/ cashflowsFirm: Growth in operating earnings/ cashflows

How risky are the cash flows from both existing assets and growth assets?Equity: Risk in equity in the companyFirm: Risk in the firm’s operations

When will the firm become a mature fiirm, and what are the potential roadblocks?

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Thedeterminantsofprice

The Market Price

Mood and MomentumPrice is determined in large part

by mood and momentum, which, in turn, are driven by

behavioral factors (panic, fear, greed).

Liquidity & Trading EaseWhile the value of an asset may not change much from period to

period, liquidity and ease of trading can, and as it does, so

will the price.

Incremental informationSince you make money on

price changes, not price levels, the focus is on incremental information (news stories, rumors, gossip) and how it measures up, relative to

expectations

Group ThinkTo the extent that pricing is about gauging what other

investors will do, the price can be determined by the "herd".

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Threeviewsof“thegap”

Viewofthegap InvestmentStrategies

TheEfficientMarketer

Thegapsbetweenpriceandvalue,iftheydooccur,arerandom.

Indexfunds

The“value”extremist

Youviewpricersasdilettanteswhowillmoveontofadandfad.Eventually,thepricewillconvergeonvalue.

Buyandholdstockswherevalue<price

Thepricingextremist

Valueisonlyintheheadsofthe“eggheads”.Evenifitexists(anditisquestionable),pricemayneverconvergeonvalue.

(1) Lookformispricedsecurities.

(2) Getaheadofshiftsindemand/momentum.

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The“pricers” dilemma..

¨ Noanchor:Ifyoudonotbelieveinintrinsicvalueandmakenoattempttoestimateit,youhavenomooringswhenyouinvest.Youwillthereforebepushedbackandforthasthepricemovesfromhightolow.Inotherwords,everythingbecomesrelativeandyoucanloseperspective.

¨ Reactive:Withoutacoremeasureofvalue,yourinvestmentstrategywilloftenbereactiveratherthanproactive.

¨ Crowdsarefickleandtoughtogetareadon:Thekeytobeingsuccessfulasapricer istobeabletoreadthecrowdmoodandtodetectshiftsinthatmoodearlyintheprocess.Bytheirnature,crowdsaretoughtoreadandalmostimpossibletomodelsystematically.

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Thevaluer’sdilemmaandwaysofdealingwithit…

¨ Uncertaintyaboutthemagnitudeofthegap:¤ Marginofsafety:Manyvalueinvestorsswearbythenotionofthe

“marginofsafety”asprotectionagainstrisk/uncertainty.¤ Collectmoreinformation:Collectingmoreinformationaboutthe

companyisviewedasonewaytomakeyourinvestmentlessrisky.¤ Askwhatifquestions:Doingscenarioanalysisorwhatifanalysisgives

youasenseofwhetheryoushouldinvest.¤ Confrontuncertainty:Faceuptotheuncertainty,bringitintothe

analysisanddealwiththeconsequences.¨ Uncertaintyaboutgapclosing:Thisistougherandyoucan

reduceyourexposuretoitby¤ Lengtheningyourtimehorizon¤ Providingorlookingforacatalystthatwillcausethegaptoclose.

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Strategiesformanagingtheriskinthe“closing”ofthegap

¨ The“karmic”approach:Inthisone,youbuy(sellshort)under(over)valuedcompaniesandsitbackandwaitforthegaptoclose.Youareimplicitlyassumingthatgiventime,themarketwillseetheerrorofitswaysandfixthaterror.

¨ Thecatalystapproach:Forthegaptoclose,thepricehastoconvergeonvalue.Forthatconvergencetooccur,thereusuallyhastobeacatalyst.¤ Ifyouareanactivistinvestor,youmaybethecatalystyourself.Infact,

youractofbuyingthestockmaybeasufficientsignalforthemarkettoreassesstheprice.

¤ Ifyouarenot,youhavetolookforothercatalysts.Herearesometowatchfor:anewCEOormanagementteam,a“blockbuster”newproductoranacquisitionbidwherethefirmistargeted.

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Anexample:Apple– PriceversusValue(myestimates)from2011to2015

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Aclosingthought…

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