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He Told Us So

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By howardroark
January 15, 2002

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You know, I've basically enjoyed the stuff that Michael Mauboussin (and more so Paul Johnson) has put up free of charge at capatcolumbia.com, even if the more recent offerings haven't quite been my taste. But I find Mauboussin's recent comments in the latest Fortune a little irritating, and not just because they were made in connection with a book that I thought was fairly disappointing. In the article, Mauboussin and co-author Alfred Rappaport are explaining how their new book, Expectations Investing helps investors reverse engineer the cash flow expectations implied by current market prices, and make decisions based on their evaluation of those expectations. In doing so, Mauboussin semi-brags:

But first, to get a sense of the impact that changes in expectations can have on stock prices, think back to February 2000, when investors were still captivated by Amazon.com's prospects. Wall Street analysts were then projecting that Amazon's sales would grow by an extraordinary 40% annually over the next ten years. Based in large part on those estimates, the stock traded for $64. According to our published analysis at the time, even those exuberant expectations could account for only about half of the $64 share price. But even without the math, shareholders ought to have been scared off by Wall Street's lofty hopes for the online retailer's otherworldly growth. Just consider for a moment: sales increasing 40%, year upon year, for an entire decade. Today the stock sells for $12, and the Street's consensus forecast for growth has been trimmed to about 15%.

It's really a little annoying that Mauboussin is boasting that his MEROI methodology can save investors from "otherwordly" and "exuberant" growth expectations such as his previously noted example of Amazon at $64 in February 2000. It's annoying because in February of 1999 Mauboussin came out with a report that has been oft-quoted on this board, called Cash Economics in the New Economy. [PDF file] That article placed Amazon in the "Emerging Capital Efficient Company" quadrant, and patronized that it is not surprising that Amazon's high valuation confuses investors who rely on conventional tests designed to measure the success of Old Economy companies, such as having positive and growing accounting earnings per share. Without any mention of implied growth expectations or MEROI or CAP, the article went to say...

Thus, we believe there are solid fundamental underpinnings behind the high valuations in the internet sector.

The examples used were Amazon, Yahoo and Dell. At the time, Amazon was trading at exactly the same $64 a share (split adjusted) as it would in February of 2000, which Mauboussin now frowns upon condescendingly (Yahoo was @ $77 a share and Dell was at $40). That article, incidentally, followed up a similar article in January of '99 entitled "Rational Exuberance" which again mentioned Amazon to support a thesis implied by the title.

Then, in June of '99, Mauboussin wrote an article entitled Get Real: Using Real Options in Security Analysis, [PDF file] where he said that Nowhere does a real option approach apply more than at a company like Amazon.com [then $59]...Amazon has taken equity stakes in a number of promising businesses, including drugstore.com and pets.com. These new ventures are best valued using options models...Many analysts assert that a business like Amazon cannot be realistically valued. We disagree. The key is attributing explicit value to the company's real options. Amazon fits the profile of a real-options-laden business: smart management, a leading business franchise, and high-end market uncertainty. Real options provide an important dimension in understanding how the market is valuing the company." Nothing at all about backing out "lofty" growth expectations in order to be scared off by an obviously excessive valuation.

I never saw the report where Mauboussin warned of Amazon's value in the spring of 2000, though I'm sure it's out there somewhere, but considering Mauboussin's previous comments at similar valuations, it really doesn't make much of a difference. Frankly, I don't really care whether Mauboussin happened to be right or wrong about Amazon or Yahoo or Etoys or whatever. All of the smartest and most valuable thinkers in every field get things very wrong once in while (Descartes) -- some of them a majority of the time (Freud). But for Mauboussin to use Amazon as an "I told you so" example to support his new groundbreaking theory (that you ought to watch out for the growth implied by market prices) runs a little thin to me.

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