Valuation
Expectations
What the market already assumes about a company’s future, which its current price encodes.
How it works
A share price is not an opinion about how good a business is. It is an opinion about how a business will do relative to what is already assumed, and the assumption is built into the price you pay.
This is why excellent companies can be poor investments and unloved ones can be good ones. The question is never whether a company will do well; it is whether it will do better than the price requires.
Where it misleads people
Most disappointment in investing comes from confusing a view about a business with a view about its price. The two are separate judgements and the second is the one that pays.
Worked example
A company that grows earnings 20% in a year where the price assumed 30% will usually fall, despite an objectively good year.
Related terms
- Reverse DCFWorking backwards from the share price to find what growth the market is already assuming.
- Consensus estimateThe average of analysts’ forecasts for a company’s revenue or earnings.
- Earnings surpriseThe gap between reported earnings and what analysts expected.
- Discounted cash flowValuing a business by estimating its future cash flows and converting them to today’s money.
- Value trapA share that looks cheap on the numbers and stays cheap because the business is deteriorating.
More in Valuation
Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.