“Prediction is very difficult, especially if it's about the future!” - Niels Bohr
As the father of the Copenhagen interpretation of quantum mechanics, Niels Bohr clearly understood the difficulty in forecasting the future. At Titan, we understand that forecasting is especially difficult when it comes to financial markets, given their inherent complexity. This creates a dilemma for investors who view the investing “game” as a competition of forecasting ability.
A core aspect of our analytical process removes the need to forecast the countless micro and macro variables that affect investment outcomes. The beauty of expectations investing is that we don’t have to correctly predict the future, we just need to understand the present. In the words of Benchmark’s Matt Cohler, "Our job is not to see the future, it’s to see the present very clearly."
This methodology, popularized by Al Rappaport and Michael Mauboussin, simply involves reverse engineering a company’s valuation by using its current price - a known variable - as our starting point. We can then ask ourselves the simple question: “What has to happen for this price to make sense?”
By comparing our views around revenue growth, profit margins, and investment quantities to consensus expectations, we are left with a binary outcome. If our view indicates that consensus expectations are too low and will need to be raised, which could drive stock prices over time, there might be a high probability we can make a profitable investment.
Many analysts and firms rely on detailed discounted cash flow models in an attempt to develop a precise view of a company’s value based on 5+ year forecasts into the future. But how can we expect to precisely forecast a multi-billion dollar company if we can’t reliably predict the value of our own bank account in five years’ time?
There probably were not many models that forecasted Amazon Web Services for Amazon in the early 2000’s. Given the ephemeral nature of technology today, how many business lines have not yet been created that will end up becoming highly valuable for today’s public companies?
Accordingly, the value-added research and analytical rigor we perform on a company’s critical factors are more valuable in the expectations approach to investing. By spending the majority of our time developing our view of these drivers in relation to the current consensus, we know we are staying focused on what matters most.
At Titan, our focus is on allocating capital to companies with durable legacy and reinvestment moats. An output of our expectations analysis is a competitive advantage period (“CAP”); the number of years of free cash flow required to justify the company’s current stock price. A company’s ROIC determines how much cash flow it generates per dollar of investment, so all else equal a higher ROIC will make a company more valuable. Taking this to its logical conclusion, a CAP below peer averages or base rates reveals that the market is undervaluing the target company.
Finally, we are also able to apply this framework to the high growth stocks that have realized upside returns recently. The difference between a company’s current market capitalization and its steady state value -- simply the capitalization of its current cash flows -- reveals the amount of future value creation the market expects from the company.
Once again, we are able to create a simplified analytical approach that doesn’t require us to figure out if a company is going to grow sales by 60% or 50% next year, as an example. Instead, the advantage of our long-term investment horizon is we only need to focus on the company’s ability to potentially generate high returns on capital and the amount of capital it can invest.
The expectations approach to investing may not be mainstream, but we are not here to provide a mainstream investing experience. Our goal will always be to implement the strategies and processes that optimize our ability to manage your capital.
So instead of trying to forecast the unpredictable future, we simply seek to understand what is knowable: the present.