process
The Expectations Gap
The rule
You only have a chance when your careful view of the business differs a lot from what the price already assumes.
Where it flips
Chasing the gap can tempt you to make up disagreement with the crowd just to feel clever, mistaking a big gap for a safe one. The fix is to insist the gap rests on something specific you understand better than the market, not on just wanting to be different.
A good business is not always a good buy. A weak one is not always a bad buy. What matters is the gap between what you expect and what the price already expects. If your view sits right on top of the market's, there is no edge, however much you admire the company. The reward comes from the size of the gap, and from the market later moving toward your view. So you hunt for wide, well-argued gaps, not just nice companies.
A worked example
Haridya likes two firms equally. The market prices one for 8% growth, where she expects 15%. It prices the other for 20%, where she also expects 20%. She buys only the first, because only there is there a gap. [illustrative]
How to spot it
- ·'great company' but no gap to the price
- ·a clear difference between your number and the built-in one
- ·reward sized to the gap, not to your love for the firm
Michael Mauboussin & Alfred Rappaport · Expectations Investing