Consilient Observer

Consilient Observer • 19-Feb-2025

Probabilities and Payoffs: The Practicalities and Psychology of Expected Value

Michael Mauboussin, Dan Callahan

Investors seek opportunities with gaps between price and value. A common approach to estimate value is to consider expected value, the sum of the products of various payoffs and their associated probabilities. We discuss some of the issues with the calculation of expected value, what the payoff picture means for investing, the implications of volatility drag, the psychology of dealing with probabilities and payoffs, and how these ideas can be helpful for investing in various asset classes.

Consilient Observer • 05-Dec-2024

Charts From the Vault: Pictures to Ponder

Michael Mauboussin, Dan Callahan

We publish some of our favorite charts that have gone unused or overlooked. We place the pictures in five categories: overall valuation, empirical regularities, capital intensity of big energy versus big technology, corporate performance, and investment management. Some challenge conventional wisdom, others address empirical observations that remain unexplained, and a handful compel a nuanced view.

Consilient Observer • 15-Oct-2024

Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation

Michael Mauboussin, Dan Callahan

Strategy explains how a firm builds a moat around its business to pursue sustainable value creation. We begin by showing why strategy matters while also distinguishing between industry and company life cycles. We turn next to industry analysis as we get the lay of the land. We then discuss industry structure and disruption and dis-integration. We finish with firm analysis. We examine the sources of added value and review pricing decisions, regulation, and brands. We include a checklist.

Consilient Observer • 24-Jul-2024
Which One Is It? Equity Issuance and Retirement Michael Mauboussin, Dan Callahan Consilient Research considers the phenomenon of companies that both issue and retire shares around the same time. This behavior may fail the central goal of capital allocation, which is to buy low and sell high. Which one is it?

Consilient Observer • 14-Jun-2024 • 49:31 Min

Counterpoint Global’s Michael Mauboussin on Capital Allocators: Pattern Recognition and Public Markets

Michael Mauboussin

Michael Mauboussin and Ted Seides discuss the recent Consilient Observer article on pattern recognition, including when it works and when it doesn’t. They then transition to discussing the changing nature of public markets, inspired by another of Michael’s recent research reports, Birth, Death, and Wealth Creation. They examine which companies have had the largest stock market capitalizations and how that population has changed.

Consilient Observer • 04-Jun-2024

Stock Market Concentration: How Much Is Too Much?

Michael Mauboussin, Dan Callahan

Stock market concentration has risen sharply over the past decade, creating a tough environment for active managers. In this report, we look at concentration over the past 75 years to see where we stand. We review which companies have been the largest and how that has changed. We ask if there is a correct level of concentration by studying other global markets and by presenting the possibility it was too low before. We then examine whether corporate performance supports the current increase.

Consilient Observer • 23-Apr-2024

Valuation Multiples: What They Miss, Why They Differ, and the Link to Fundamentals

Michael Mauboussin, Dan Callahan

Most investors “price” the stocks of companies by using valuation multiples instead of “valuing” them based on future cash flows and fundamentals. We address what multiples miss and why they have become less informative. We examine how the two most popular multiples, P/E and EV/EBITDA, can provide different signals about a stock’s relative attractiveness. We then take a deep look at EV/EBITDA. We do not discourage the use of multiples, but users should understand the underlying value drivers.

Consilient Observer • 28-Feb-2024
Cost of Capital and Capital Allocation: Investment in the Era of “Easy Money” Michael Mauboussin, Dan Callahan We examine the counterintuitive behavior of U.S. public companies in the recent regime of “easy money” marked by below-average interest rates.

Consilient Observer • 30-Jan-2024
Increasing Returns: Identifying Forms of Increasing Returns and What Drives Them Michael Mauboussin, Dan Callahan Understanding the five areas of micro and macroeconomics where increasing returns applies and show their relevance to investors.

Consilient Observer • 13-Dec-2023
Pattern Recognition: Opportunities and Limits Michael Mauboussin, Dan Callahan Explore the powers and perils of pattern recognition, which investors often credit. We define it, discuss when it works better, and offer ways to improve it.

Consilient Observer • 24-Oct-2023

Total Shareholder Return

Michael Mauboussin, Dan Callahan

We study the sources of total shareholder return (TSR) and tie them to underlying economic principles. This is useful to assess the prospective returns of a stock and to create a framework for flagging value traps. The analysis reveals that few investors in the stocks of companies that pay dividends earned the TSR and refutes the common belief that dividends contribute to capital accumulation. This framework gives investors a checklist of drivers and the tools to assess them.

Consilient Observer • 26-Sep-2023

Trading Stages in the Company Life Cycle

Michael Mauboussin, Dan Callahan

The life cycle captures the stages of a company’s existence, from birth to growth to maturation to decline. Knowing where a company is in its life cycle is helpful for assessing capital allocation, financing costs, governance, and valuation. In this report, we use the cash flow statement to place companies in the proper stage. We then show the average characteristics of companies in each stage, their rates of transition between stages, and the past shareholder returns of each transition cohort.

Consilient Observer • 25-Jul-2023

Birth, Death, and Wealth Creation

Michael Mauboussin, Dan Callahan

We examine the demographics of public companies and their patterns of wealth creation. We focus on the last half century in the U.S. and review the “births” and “deaths” of public companies. We also discuss changes in market composition. Nearly 60 percent of companies have failed to create value, and 2 percent have created 90 percent of the aggregate wealth. This suggests two strategies for portfolio construction: seek broad diversification or aim to own the wealth creators.

Consilient Observer • 06-Jun-2023

ROIC and the Investment Process

Michael Mauboussin, Dan Callahan

This report extends our analysis of the ROICs for public companies in the U.S. and updates the data to cover the years 1990 to 2022. We start by providing the latest ROIC figures, then examine the link between changes in ROICs and total shareholder returns (TSRs), and finish by reviewing elements of competitive strategy as well as persistence of ROIC by sector.

Consilient Observer • 18-Apr-2023

Stock-Based Compensation

Michael Mauboussin, Dan Callahan

U.S. companies are increasingly paying employees with stock-based compensation (SBC) rather than cash. We begin with data showing overall trends, then turn to the accounting issues, and wrap up by evaluating the strengths and weaknesses of SBC. Ongoing shareholders typically realize more dilution with young companies than with old ones because SBC tends to be more significant, and buybacks less significant, for young companies. Research is equivocal on the benefits commonly cited for SBC.

Consilient Observer • 22-Mar-2023

Confidence

Michael Mauboussin, Dan Callahan

Probability and confidence are distinct concepts, and we believe it is useful for investors to separate them. For example, the price of two potential investments may present the same discount to expected value, but confidence in the probabilities for one may exceed those of the other. That nuance may be relevant for determining the appropriate weighting of securities or evaluating diversification.

Consilient Observer • 15-Feb-2023

Cost of Capital

Michael Mauboussin, Dan Callahan

This is a guide to estimating the cost of capital, a measure of both expected return and the discount rate. For example, investors discount future free cash flows at the cost of capital to come up with a present value. Our goal is to find a figure that reflects opportunity cost sensibly, is economically sound, and gives the investor and businessperson a practical solution. We recommend settling on a reasonable cost of capital and then allocating the bulk of time thinking about future cash flows.

Consilient Observer • 14-Dec-2022

Capital Allocation

Michael Mauboussin, Dan Callahan

Capital allocation is a key job of management, but not all know how to allocate effectively. In this report, we establish the foundation by reviewing the sources and uses of capital and then show how U.S. companies have allocated capital since 1985. Next, we review the alternatives in detail, including intangible investments, and offer a guide for thinking about the prospects for value creation. We finish with a framework for assessing a company’s capital allocation skills.

Consilient Observer • 09-Nov-2022

ROIC and Intangible Assets

Michael Mauboussin, Dan Callahan

We extend the analysis from our recent report, “Return on Invested Capital,” by adjusting ROIC for all companies to reflect intangible investment. While the median and aggregate ROIC for the adjusted figures is similar to the traditional one, the main result is that extremely high and low ROICs regress toward the mean. We believe these adjustments represent a step toward a more accurate view of the magnitude and return on investment.

Consilient Observer • 06-Oct-2022
Return on Invested Capital Michael Mauboussin, Dan Callahan We discuss how to calculate return on invested capital (ROIC) and show how it is connected to free cash flow, economic profit, and growth. We work through the challenges in estimating it, present empirical data, review how adjusting for intangible investments can reshape the figures, and include a case study.

Consilient Observer • 15-Sep-2022

Market Share

Michael Mauboussin, Dan Callahan

We examine whether a study of market share and related concepts can help us determine if a company has a sustainable competitive advantage. This takes us on a journey that includes life cycles, market share, concentration, markups, intangibles, and "superstars". We study the link between some of these variables and return on investment and provide some analytical tools along the way. We finish with some case studies to see how these ideas apply to a handful of industries.

Consilient Observer • 20-Jul-2022

Good Losses, Bad Losses

Michael Mauboussin, Dan Callahan

Investors must look past simple measures of profits to understand a business’s true ability to create value. The rise of intangibles means more investments are expensed versus capitalized, which makes financial statements appear distorted versus those of the past. Academics distinguish between GAAP losers, companies that have losses but a high return on investment, and real losers, or those that have expenses unrelated to investment that exceed sales. Evidence from recent decades shows GAAP losers produced attractive shareholder returns relative to the real losers and profitable companies.

Consilient Observer • 15-Jun-2022

New Business Boom and Bust

Michael Mauboussin, Dan Callahan

Burgeoning industries often follow the same developmental pattern as a child’s brain, with an overproduction of options followed by a pruning of those that are not useful. This appears wasteful but is in fact an elegant solution. We discuss this pattern for companies, describe why investors should care, and offer some current examples of where this pattern of entry and exit is playing out.

Consilient Observer • 10-May-2022

Wealth Transfers

Michael Mauboussin, Dan Callahan

The goal of capital allocation is to put resources to their best use to create long-term value per share for ongoing shareholders. The first major part of capital allocation is investing in the business. The second is transacting with mispriced securities, which introduces the potential for wealth transfers between stakeholders. Astute investors appropriately focus on a management's ability to make investments in the business, but they should also pay attention to management actions with regard to buying and selling the company’s stock.

Consilient Observer • 12-Apr-2022

Intangibles and Earnings

Michael Mauboussin, Dan Callahan

The shift from tangible to intangible investments has complicated the ability to interpret financial statements. One solution is to record intangible investments on the balance sheet and then amortize them over their useful lives. These adjustments recast profitability for some companies and are inconsequential for others. Overall, we estimate that earnings for the S&P 500 would be about 10 percent higher with these changes. This suggests great caution in comparing earnings or valuation multiples over time.

Consilient Observer • 16-Mar-2022

Feedback

Michael Mauboussin, Dan Callahan

Continuous process improvement is essential to achieving outstanding long-term outcomes. Receiving timely and accurate feedback—information used as a basis for improvement—can enhance the process and make you a better forecaster. We discuss multiple facets of process improvement, including getting the right people and helping them thrive, the role of organizational structure in fostering good decision making, and specific mechanisms to sharpen execution. We draw on principles from other fields but focus primarily on the investment management industry.

Consilient Observer • 27-Jan-2022

Underestimating the Red Queen

Michael Mauboussin, Dan Callahan

Organisms allocate energy between growth and maintenance and repair. They stop growing when maintenance requires all of the energy. Substitute capital for energy and companies appear to follow a similar trajectory. This is important because you can anticipate a company’s growth only if you understand how much capital it spends on growth versus maintenance. Most executives and investors likely underestimate maintenance spending. Steps toward better understanding include a proper assessment of maintenance capital expenditures and a separation of SG&A into investment and maintenance components.

Consilient Observer • 06-Oct-2021

Categorizing for Clarity: Cash Flow Statement Adjustments to Improve Insight

Michael Mauboussin, Dan Callahan

Accounting has not kept pace with the changing economics of businesses, which has created a huge gap between what companies report in their financial statements and what an investor needs to understand a business. To better categorize activities, we suggest making adjustments within the statement of cash flows pertaining to stock-based compensation, leases, and intangible investments. We believe these adjustments substantially improve the description of a business. We share a case study of Amazon for 2020 to make the concepts more concrete.

Consilient Observer • 03-Aug-2021

Everything Is a DCF Model

Michael Mauboussin, Dan Callahan

We suggest the mantra “everything is a DCF model.” Whenever investors value a stake in a cash-generating asset, they should recognize they are using a discounted cash flow (DCF) model. The topic deserves attention because many market participants don’t think DCF models are relevant, and many use heuristics for value without recognizing the purpose and limitations of the shorthands. The intrinsic value, determined by the present value of future cash flows, attracts the price like a magnetic force. This means it is useful for investors to keep in mind the value drivers of a discounted cash flow model.

Consilient Observer • 23-Jun-2021

The Impact of Intangibles on Base Rates

Michael Mauboussin, Dan Callahan

The shift in investments from tangible to intangible assets has important implications for how investors should think about corporate growth rates. Companies with more intangible assets can grow faster, but they can also become irrelevant and shrink faster. Our analysis of historical sales growth rates for U.S. companies reveals both of these results: higher growth and more dispersion, on average, for companies and industries with the highest intangible asset intensity. Skillful investors may be able to identify the companies that will grow faster than expected, hence providing the potential for attractive returns.

Consilient Observer • 19-May-2021

The Economics of Customer Businesses

Michael Mauboussin, Dan Callahan

This report focuses on the customer as the basic unit of analysis in understanding value. The idea of customer lifetime value has been around for decades, but we believe our discussion is richer and more nuanced than what many companies and analysts present. We discuss a framework called customer-based corporate valuation, which links customer economics to shareholder value and offers a more robust way to forecast revenues. We also show the limitations of common ratios such as customer lifetime value to customer acquisition cost (LTV/CAC), explore how companies can create consumer and supplier surplus, provide a case study, examine trade-offs in the drivers of value, and explore common errors.

Consilient Observer • 21-Dec-2020

WACC and Vol

Michael Mauboussin, Dan Callahan

The weighted average cost of capital (WACC) and volatility (vol) generally move in lockstep, but 2020 is unusual because the cost of capital is well below its historical average and volatility is well above its historical average. The prime beneficiaries of these patterns are companies rich with real options. In this report, we define real options, discuss what businesses are likely to have them, review the valuation implications, and finish with a way to use real options analysis with traditional valuation.

Consilient Observer • 15-Sep-2020

One Job

Michael Mauboussin, Dan Callahan

The one job of an equity investor is to take advantage of gaps between expectations and fundamentals, which requires an understanding of the magnitude of investment and return on investment in order to properly anticipate free cash flows. With investments shifting more toward intangible assets, this report discusses the measurement and characteristics of intangible assets and reviews the implications of the growth of intangibles for investors.

Consilient Observer • 04-Aug-2020
Public to Private Equity in the United States: A Long-Term Look Michael Mauboussin, Dan Callahan Over the past quarter century there has been a marked shift in U.S. equities from public markets to private markets controlled by buyout and venture capital firms. This change has had reverberations for asset managers, investors, executives, and policy makers.

Consilient Observer • 09-Jun-2020
The Math of Value and Growth Michael Mauboussin, Dan Callahan We show how corporate valuations change as we vary assumptions about growth, return on incremental invested capital, and the discount rate.

Consilient Observer • 20-May-2020
Myth Busting, Popular Delusions, and the Variant Perception Michael Mauboussin, Dan Callahan We address four myths or popular delusions in the investment industry.

Consilient Observer • 14-Apr-2020
Dispersion and Alpha Conversion Michael Mauboussin, Dan Callahan An investor’s success requires both skill and opportunity. We look at how investors can express skill and use dispersion to measure the opportunity set.