BiographyAlfred Rappaport is the Leonard Spacek Professor Emeritus at J. L. Kellogg Graduate School of Management, Northwestern University and directs shareholder value research for L.E.K. Consulting. He originated the Shareholder Scoreboard for the Wall Street Journal.
Books by Alfred Rappaport
Follow the cash.
Investor returns come from two sources of cash - dividends and changes in share prices. But a company cannot pay dividends unless it is able to produce positive cash flows. So without the prospect of future cash flows, a company commands no value. Stock prices therefore reflect transactions between investors willing to sell the present value of a company's expected cash flows and buyers who are betting on higher cash flows in the future. Cash flow is how the market values stocks.
Forget earnings and price-earnings multiples.
Savvy investors don't rely on short-term metrics such as earnings and price-earnings multiples because they fail to capture the long-term cash-flow expectations implied by the stock price. Indeed, the most widely used valuation metric in the investment community, the price-earnings multiple, does not determine value but rather is a consequence of value. The price-earnings multiple is not an analytic shortcut. It is an economic cul-de-sac.
Read market expectations implied by stock price.
Rather than forecast cash flows, expectations investing starts by reading the collective expectations that a company's stock price implies. By reversing the conventional process, you not only bypass the difficult job of independently forecasting cash flows but you can also benchmark your own expectations against those of the market. You need to know what the market's expectations are today before you begin to assess where they are likely to move in the future.Taken from The Global-Investor Book of Investing Rules