Whitney Tilson shares another chapter called Expectations, Inflection Points, Variant Perceptions, and the Herd, from his upcoming book titled, The Rise and Fall of Kase Capital.
Q2 2020 hedge fund letters, conferences and more
3) Here's another excerpt from my upcoming book, The Rise and Fall of Kase Capital:
Expectations, Inflection Points, Variant Perceptions, and the Herd
Good valuation work is almost always rooted in doing accurate discounted cash flows, but here's a shortcut that often works for stocks. Just think about expectations.
Almost every stock price reflects the consensus expectations that investors have about a company's future. It's usually not hard to figure out – just read a few analyst reports.
Once you know what the expectations are, what determines whether a stock price goes up or down is whether a company's performance exceeds or underperforms those expectations.
In an ideal world, you can identify what I call an inflection point – the moment right before a stock takes off. This usually happens when a company starts beating expectations by a wide margin.
Every investor dreams of finding inflection points, but they're very difficult to identify. The good news, however, is that you don't have to have perfect timing. As John Maynard Keynes once said, "It's better to be roughly right than precisely wrong."
If you believe a company/stock is at an inflection point, then you have a variant perception.
Legendary hedge-fund manager Michael Steinhardt coined the phrase, which simply means "what do you believe that's different from the consensus view?"
It's easy to develop a variant perception – they're a dime a dozen. What's hard is being right because the market is super-efficient. That's especially true in today's investing world, in which a lot of smart people – many using supercomputers – are looking for even the tiniest mispricing.
To have a correct variant perception, you must have a unique piece of data, insight, or analysis. This is much more likely to happen if you're in your sweet spot – a country, market, or industry in which you have deep knowledge, experience, and relationships.
Developing a correct variant perception typically requires a lot of hard, focused work, often over years, even decades.
And never forget that it's very easy to be the sucker at the poker table – avoid this at all costs!
Here are examples, all discussed elsewhere in this book, of how I developed insights that led to correct variant perceptions and catching inflection points:
- Netflix (NFLX): I met twice privately with CEO Reed Hastings, for more than an hour each time, and gained an understanding of him and the company.
- Berkshire Hathaway (BRK-B): I've studied Warren Buffett, Charlie Munger, and the company deeply for more than two decades, including attending the last 21 annual meetings in Omaha.
- Lumber Liquidators (LL): I had a source who told me that Chinese suppliers were sending the company toxic, formaldehyde-drenched laminate flooring.
- McDonald's (MCD): I spoke with a franchisee who told me about the tremendous turnaround that was underway.
- CKE Restaurants: I called dozens of Hardee's restaurants to determine that the new Thickburger was a home run.
- JetBlue (JBLU): I spoke with numerous people in the company and industry as I wrote five articles about it.
In most of these cases, my variant perception was proven correct fairly quickly – in other words, I nailed the inflection point pretty well. But I've found that that tends to be the exception, not the rule. It was more than a year before Netflix and Lumber Liquidators worked, and McDonald's kept going down for three months after I first bought it. The reality is that it can sometimes take years before your variant perception is proven right.
In the meantime, you are typically bombarded by the conventional wisdom as expressed by the market. (As the French investor Jean-Marie Eveillard said, "It's much warmer inside the herd.")
When asked about the most difficult part of being an investor, Steinhardt said...
The hardest thing has been having the courage to go against the dominant wisdom of the time, to have a view that is at variance with the present consensus and bet that view.
Best regards,
Whitney
