When I am speaking to a peer or a sales guy about a stock and mention a potential catalyst or driver for the stock, I get hit by “Isn’t that already being priced in” . i am always sort of confused on what the right way to look at this is ? In an ideal world of efficient markets, all the information should be priced in and the stocks should be tradiing at their highest or maximum realizable prices. But , in the real world, stocks react slowly as your thesis plays out. Can i say I don’t think it’s pricing in the info because the stock is still below our PRice Target ? What indicates if a piece of information is being priced in or not ?
There is no simple answer to this question as it varies by ticker and is situational, and even then is usually debatable. In general, my experience has been that most larger mid cap and large cap stocks have most information priced in most of the time. You’re not going to find any revolutionary edge looking at Coca-Cola, for example, because there are 20+ sell side analysts covering the stock and umpteen more on the buy side, and you can’t really learn anything these people don’t already know. It’s also a slow growing mature business where the status quo is the norm and there isn’t that much opportunity for “new things” to happen. You might be able to make money based on a divergent view for the outlook of the dollar or interest rates, but basically, you can’t really outgun the rest of the Street since there isn’t “that much action” to be had on a name like KO (although there are ridiculous opportunities sometimes, like when Buffet bought Coke at 8x EPS or whatever it was, so there are times when there isn’t any “informational edge” out there, but the market merely isn’t paying attention for some reason – that’s almost two separate issues, although it’s a fine distinction). On small and mid cap names, you can do primary research via channel checks, talking to industry experts (hopefully not through Global Level lol), talking to execs at competitors, etc. and develop unique insight into the direction of the company that allows you to capture alpha because you learn something the market doesn’t know (I’m not talking about inside info but proprietary analysis), and therefore isn’t priced in. This is hard to do and you have to know where and how to look, but in general, this is how the big money is made. My experience is that what the company says (and by extension what the sell side says) is priced in, as well as other “obvious” factors, but that reality sometimes differs from perception / corporate spin, and the reality sometimes is not priced in.
So there is no point to buying MSFT today because of an expected corporate upgrade to Win 7 in 2011. Since this is so well known and the company has been saying that they expect a huge rush of enterprise upgrades this year , it should be already priced intot he MSFT stock. Right ?? It seems the rule of thumb is that public information is always priced in, unless as you said in some scenarios the market is ignoring it and your numbers are higher than the street’s or you think the multiple should be higher than the current multiple.
What they are asking is: Why do you have an edge? Broadly, two ways to beat the market: 1) Have better information. This is still possible and legal in some industries. In this instance there is no question of info being priced in because you are the sole (or one of a few) holder of this valuable info. 2) Analyze the existing info better than other market players. Here is where people will ask you if something is priced in. To respond, you need to know what the market is currently pricing, how much your view diverges from that market consensus and why it divierges. These are things you should be ready to discuss if you are pitching a stock.
That’s what the issue is. How do you judge what the market is pricing in ? Is it just based on consensus estimates versus my estimates. Going back to my MSFT example, is it as simple as we think Win 7 revenues this year will be $10b but the consensus is only $8b and hence we think that the numbers will beat consensus. Correct ? But , the consensus numbers are always almost based on company’s guidance so not much scope to outperforming consensus unless the company has been sandbagging and setting lower expectations.
res420 Wrote: ------------------------------------------------------- > Is it just based on consensus estimates versus my estimates. Going > back to my MSFT example, is it as simple as we > think Win 7 revenues this year will be $10b but > the consensus is only $8b and hence we think that > the numbers will beat consensus. Correct ? Yes, then you need to articulate your rationale for above consensus Windows 7 revenues. Let me further break down the 2nd point I made in my previous post: 2) Analyze the existing info better than other market players. Broadly, there are two ways to do this: 1) Believe the fundamentals are different from consensus. 2) Exploit some market behavioral bias. - these two categories do not have a pure play. They are always mixed, but that is how I would break it down.
Thanks. This was very helpful.
res420 Wrote: ------------------------------------------------------- > That’s what the issue is. How do you judge what > the market is pricing in ? Is it just based on > consensus estimates versus my estimates. Going > back to my MSFT example, is it as simple as we > think Win 7 revenues this year will be $10b but > the consensus is only $8b and hence we think that > the numbers will beat consensus. Correct ? But , > the consensus numbers are always almost based on > company’s guidance so not much scope to > outperforming consensus unless the company has > been sandbagging and setting lower expectations. Yeah, this is likely not a great bet. MSFT is massive. How are you going to out guess consensus? The stock will immediately react to the guidance, and any alpha going forward will be determined by your ability to know whether guidance is too high or low, which you won’t be able to do in this case. Contrast this to a $100M revenue company with no analyst coverage, and maybe even no guidance. You can add value there and there aren’t going to be as many eyes on the numbers, so you might be able to develop an edge. It’s not easy, but it can be done.
Agreed that one has a better chance of outguessing the consensus for a small company that is not closely watched/followed. But, on the flip side, doesn’t lack of attention also hurt. If the company beats consensus, not many people are going to care. Right ??
res420 Wrote: ------------------------------------------------------- > Agreed that one has a better chance of outguessing > the consensus for a small company that is not > closely watched/followed. But, on the flip side, > doesn’t lack of attention also hurt. If the > company beats consensus, not many people are going > to care. Right ?? No, people care. Everyone loves a winner.
Thanks for all your insights.
bromion Wrote: ------------------------------------------------------- > No, people care. Everyone loves a winner. unless you have the puts… there’s also a %probability to cover the uncertainty as in takeover news. the price target is there, but its not certain until the deal is done.