Michael Mauboussin, Columbia University finance professor and head of Morgan Stanley’s Consilient Research program, is probably my favourite thinker on markets. For one, he wrote what I believe is the single best short paper ever aimed at both new and experienced investors during his tenure as chief investment strategist at U.S. asset manager Legg Mason.
Mr. Mauboussin recently sat down with Institutional Investor for an interview and his responses were typically insightful.
When asked for the primary differences between good and great investors, Mr. Mauboussin answered “[it] rarely has to do with the tools they’re using but rather relates to their skills in decision-making — especially during challenging and stressful situations.”
This is a key point. Great investors can use a variety of tools. Momentum-based indicators like trailing six month returns are one example. Mr. Mauboussin favours cash flow and profitability multiples like return on invested capital.
But when and how to apply these techniques in market transactions with the highest probability of success determines performance.
Another important insight - and a controversial one - is that investors pay too much attention to common valuation multiples like price to earnings and price to EV/EBITDA (enterprise value divided by earnings before interest, taxation, depreciation and amortization). His analysis shows that these simple valuation techniques – which he admits using himself occasionally as shorthand – incorporate too many economic assumptions to be definitive regarding stock values.
Mr. Mauboussin’s new book, written with economist Alfred Rappaport, is called “Expectations Investing: Reading Stock Prices for Better Returns”. It details their preferred investment strategy, how to assess the growth prospects embedded in stock prices and where they diverge from an expected value. This expected value is derived from probability-based scenario analysis. He summarizes the approach as “We start with the only thing we know for sure — the price — and then assess what has to happen to realize an attractive return.”
I highly recommend investors read the entire interview. It includes further insights on why the best market forecasters are usually the best at filtering market noise, the importance of cost of capital in analyzing a company, how maintenance-based capital expenditure resembles the animal kingdom and when index investing might begin to distort stock prices. There are few more credible sources for these discussions.
-- Scott Barlow, Globe and Mail market strategist
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Soaring U.S. stocks make case for diversifying
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Compiled by Globe Investor Staff