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PVGO Formula for Equity Valuation (Long Version)
1. The PVGO Thought Process For EquityValuation
By Michael O. Ijeh
August 8, 2016
2. Keynes’s Famous Beauty Contest Quote For The Stock Market
"It is not a case of choosing those [faces] that, to the best of one's judgment, are really the
prettiest, nor even those that average opinion genuinely thinks the prettiest.We have reached
the third degree where we devote our intelligences to anticipating what average opinion
expects the average opinion to be.And there are some, I believe, who practice the fourth, fifth
and higher degrees.“
Keynes, GeneralTheory of Employment, Interest and Money, 1936
2
3. Keynes’s Belief – Is It True?
Keynes believed that behavior of a beauty pageant judge was happening in the stock market
This would have people pricing shares not based on what they think their fundamental value is, but
rather on what they think everyone else thinks their value is, or what everybody else would predict
the average assessment of value to be.
It could be true, but one can still gain a competitive advantage in the stock market by viewing
the market in a different manner
Based on “Keynesian Beauty Contest”Wikipedia webpage
3
4. How To Gain A Competitive Advantage In Stock Selection
Superior Forecast*
DifferentView of Valuation*
Understanding Investor Sentiment*
Having Insider Information
So is there a way to combine all of these methods for gaining a competitive
advantage in stock selection? (Well, maybe not the insider information)
*Based on FaVeS framework from AnalystSolutions
4
5. Challenges With TraditionalValuation Techniques
Market Approach (Multiples)
Can be tough finding a good peer group of
comparable companies since no two companies are
the same
Market valuations can fluctuate dramatically
Market prices aren’t always based on fundamentals
or expectations, but even on irrational behavior and
events uncorrelated to a company’s business
Implicit expectations are baked into a multiple
Income Approach (DCF)
Can be tough determine the forecast horizon and
the many assumptions that go along with the model
Shorter horizon – TerminalValue contributes too much
to theValue of the company
Longer horizon – Greater chance for forecasting error
and will probably be outside of investment horizon
Could possibly be “garbage in, garbage out”
And is there a way to combine both of these methods for stock selection? 5
6. So How Can an Investor Gain A Competitive Advantage Without Falling
Into The Common Pitfalls For EquityValuation?
By trying to understand potential returns the market expects from a stock for a
given investment horizon, and deciding if the market’s expectations are:
Too High,
Too Low, or
Just Right
From there, an investor can make a recommendation as to if a stock is truly under-,
over-, or fairly valued
6
7. So How Can We Understand The Market’s Expectations?
Can potentially be done by using the PresentValue of Growth Opportunities (PVGO)
Thought Process:
𝑽𝒂𝒍𝒖𝒆 𝑭𝒊𝒓𝒎 = 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑭𝒊𝒓𝒎 𝒘𝒊𝒕𝒉 𝑵𝒐 𝑮𝒓𝒐𝒘𝒕𝒉 + 𝑮𝒓𝒐𝒘𝒕𝒉 𝑬𝒙𝒑𝒆𝒄𝒕𝒂𝒕𝒊𝒐𝒏𝒔
or
𝑽𝒂𝒍𝒖𝒆 𝑭𝒊𝒓𝒎 = 𝑴𝒊𝒏𝒊𝒎𝒖𝒎 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑭𝒊𝒓𝒎 𝑻𝒐𝒅𝒂𝒚 + 𝑬𝒙𝒑𝒆𝒄𝒕𝒆𝒅 𝑽𝒂𝒍𝒖𝒆 𝒐𝒇 𝑭𝒊𝒓𝒎 𝑻𝒐𝒎𝒐𝒓𝒓𝒐𝒘
7
8. PVGO Thought Process
Based off of the Gordon Growth Model, using this train of thought can help an investor understand
the market’s expected returns for a given stock and weigh it against the risk
Goal of this process is to find stocks of companies that have low growth expectations relative to an
investor’s assessment of a company’s risk and potential returns
𝑽𝒂𝒍𝒖𝒆 𝑭𝒊𝒓𝒎 𝒕 =
𝑬𝒄𝒐𝒏𝒐𝒎𝒊𝒄 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 𝒕+𝟏
𝑫𝒊𝒔𝒄. 𝑹𝒂𝒕𝒆−𝑮𝒓𝒐𝒘𝒕𝒉 𝑹𝒂𝒕𝒆
𝑽𝒂𝒍𝒖𝒆 𝑭𝒊𝒓𝒎 𝒕 =
𝑬𝒄𝒐𝒏𝒐𝒎𝒊𝒄 𝑩𝒆𝒏𝒆𝒇𝒊𝒕 𝒕
𝑫𝒊𝒔𝒄. 𝑹𝒂𝒕𝒆
+ 𝑷𝑽𝑮𝑶
8
9. Three Main Components Of The PVGO Thought Process
1. The Economic Benefit
I. Which “benefit” will be used? EPS, FCF, Dividends, EBITDA, Revenue, NOPAT, etc.
II. Directly finding EquityValue or indirectly by finding the value of the enterprise first?
III. Timeframe of past “benefit”? LTM, 3 or 5 year average, weighted averages, etc.
2. The Discount Rate / Cost of Capital
I. CAPM
II. Build-up Model
III. Cost of Debt plus Risk Premium
3. Growth Expectations (PVGO %)
I. Past trends in growth and margins for the economic benefit used
II. Potential size of a company’s industry
III. Current stage of Company/Industry life cycle
IV. Competitive Analysis
V. Other Fundamental Analysis
VI. Investment Horizon and Implications
9
10. How PVGO Relates To A Company’s RiskWithin Their Life Cycle
PVGO, Discount Rates, and the Corporate Life Cycle
Growth Stage Start-up Young Growth High Growth Mature Growth Mature Stable Decline
Description Business idea
Create business
model
Build the business, creating revenues
Grow business via operating leverage,
create profitability
Defend business from new competitors and
markets
Scale down business, consolidate
Investing
Option Investing (go
for upside)
Growth Investing
(maximize value from
growth)
Scaling Investing (scale up growth)
Defensive Investing (protect the
competitive advantage)
Maintenance Investing (preserve value) Divesting (shed past investments)
Financing All Equity All Equity
First signs of debt capacity, but little
to no benefits
Debt capacity expands, and the benefits
of borrowing will start to exceed the
costs
Benefits of borrowing significantly exceed
costs
Pay down debt as assets are sold
Revenues None
Finding first
customers, may need
to "grow at all costs"
to gain traction
Revenue growth increases rapidly,
possibly even doubling every year
Revenue growth starts to slow down, but
still growing faster than the broad market
Revenues are more in line with the rest of
the broad market, as competitors start to
saturate the market
Revenues start to decline; only way to grow
significantly is via M&A
Profits / CF None
Cash burn is
extremely high
Signs of profitability start to appear
as losses decrease; business is close
to being CF positive
Profitability starts to grow significantly via
operating leverage
Profitability growth starts to slow down;
business may start to accumulate cash on
hand
Profitability drops off dramatically, as assets are
sold, decreasing the business's earnings power
Value Driver
(Economic
Benefit)
Market Potential
Key Performing
Indicators / Operating
Data
Revenue / Gross Profit Gross Cash Flow / EBIT / EBITDA Free Cash Flow / Net Earnings Book Value / invested Capital / Dividends
Discount Rate
(Cost of
Equity)
Extremely high, as the
chance of failure is
very high (>50%)
Still very high, as the
business model is still
unproven (40-50%)
Not as high as before since the
business model has gained traction,
but still high due to little to no
profitability (30-40%)
As the business begins to grow profits
and cash flows, the question now is if the
business can be scaled up; returns are still
expected to be higher than the broad
market (15-30%)
As revenues become more in line with the
rest of the broad market, so too should
investor's expectations for returns, as the
business's operational results start to
become more predictable (7-15%)
Investor expectations aligns with what growth
within the entire sector and the overall economy
(3-7%)
PVGO %
(FCF/EPS)
Well above 100%, if
not closer to 1000%
due to the market
potential
Still well above 100%;
must start paying
attention to
investments and
understand how
they'll enhance value
Still at or around 100%, especially if
the business is close to or just
becoming profitable
PVGO finally starts to decline, as the
business starts to reach it's potential
from a profitability standpoint; dividends
may start to come into play (60-90%)
Similar to Revenues and the discount rate,
PVGO starts to align with the broad market
as well (30-60%)
PVGO is below the market, as profits are
expected to continue to decrease; may start to
expect dividends to drive PVGO more than
growth in profits (0-30%)
10
11. How PVGO Relates To A Company’s RiskWithin Their Life Cycle (Cont.)
Time
Growth in Revenues and ProfitsThroughout the
CLC
Revenues Profits
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
0%
50%
100%
150%
200%
250%
Time
Discount Rate and PVGO %Throughout CLC
PVGO (LHS) Discount Rate (RHS)
Young Growth
Young
Growth
Start-up
Start-up
High
Growth
High
Growth
Mature
Growth
Mature
Growth
Mature
Stable
Mature
Stable
Decline
Decline
CLC methodology is sourced from Aswath Damodaran’sYouTube videos and individual analysis
11
14. What The PVGOThought Process Can Tell Us About The Market Over
The Past 25Years…
Since 1990, the average market participant could expect:
2% DividendYield,
7-8% EPS Growth,
8-9% Discount Rate based off of CAPM for Cost of Equity,
9-10% Discount Rate based off of GGM for Cost of Equity,
And 35% of the price based on future growth expectations (meaning 65% of value can
be seen today)
14
15. Measuring The Market’s Growth Expectations
After knowing the percentage of growth expectations baked into the market price, an investor could then back
into the compounded annual growth rate for the economic benefit used based on a certain time horizon.
Since most investors look to hold a stock for 3-5 years, the growth expectations of the S&P 500 equate to a 15-
16% CAGR expectation over a 3-year period, or a 9% CAGR expectation over a 5-year period.
At a 15.5% Growth Rate
No-Growth %
65%
PVGO %
35%
$100 $54
Years 0 1 2 3
$100 $116 $133 $154
At a 9% Growth Rate
No-Growth %
65%
PVGO %
35%
$100 $54
Years 0 1 2 3 4 5
$100 $109 $119 $130 $141 $154
15
16. So What About The S&P 500 Index Now?
1. Economic Benefit Used
1. TTM EPS (2Q15-2Q16)
1. $98.75 – from S&P Dow Jones Indices - S&P 500 Earnings And Estimate Report, 8/3/16
2. Discount Rate Used
1. 1.53% - 10Year U.S.Treasury Note
2. 6.27% - (+) Implied ERP - TTM CashYield from Aswath Damodaran’s website
3. 7.80% - Discount Rate
3. PVGO %
1. $98.75 – TTM EPS
2. 7.80% - (/) Discount Rate
3. $1,266.03 – MarketValue of S&P 500 with No-Growth Expectations 16
17. Implications of S&P 500’s PVGO Status
With the S&P 500 at $2,164.25 (8/5/16), the No-Growth value of the S&P 500 represents 59% of the market price, meaning 41% of the market
price represents expected growth in value in the future.
The PVGO % represents ~20% CAGR over a 3 year investment horizon, or ~11% CAGR over a 5 year investment horizon.
The key question to ask is are the implied growth rates of the market reasonable, too optimistic, or too pessimistic?
For comparison, the S&P 500 Earnings And Estimate Report from S&P Dow Jones Indices projects 28% EPS growth for the next twelve months,
and 23% CAGR through the end of 2017. Based on these initial estimates, an investor can extrapolate from these estimates to the S&P’s EPS
growing at 13-14% over the next 3-5 years.This long term growth projection is at the lower end of the 11-20% CAGR range that’s baked into
the market, and higher than the historical PVGO % baked into the market.
If any minor hiccups in the overall economy happen or corporate earnings doesn’t start growing positively , the S&P 500 EPS may not be able to
grow at the expected rate.
This leads one to believe the market is a little rich, but not completely overvalued based on growth projections.
At a 19.6% Growth Rate
No-Growth %
59%
PVGO %
41%
$1266 $898
Years 0 1 2 3
S&P 500 $1266 $1514 $1810 $2164
At a 11.3% Growth Rate
No-Growth %
59%
PVGO %
41%
$1266 $897
Years 0 1 2 3 4 5
S&P 500 $1266 $1409 $1569 $1746 $1943 $2163
Update
17
18. So What AboutValuing a Company? McDonald’s (NYSE: MCD) Maybe…
1. Economic Benefit Used
1. TTM EPS (2Q15-2Q16)
1. 5.24 – fromYahoo Finance, 8/3/16
2. Discount Rate Used
1. 6.27% - (+) Implied ERP - TTM CashYield from Aswath Damodaran’s website
2. 0.66 - (x) MCD’s Beta from Google Finance 8/3/16
3. -0.50% - (+/-) Size Adjustment from Individual Analysis
4. 1.53% - (+) 10Year U.S.Treasury Note
5. 5.17% - MCD’s Discount Rate
3. PVGO %
1. 5.24 – TTM EPS
2. 5.17% - (/) Discount Rate
3. $101.39 – MarketValue of MCD per share with No-Growth Expectations
18
19. Implications of MCD’s PVGO Status
With MCD having a market cap of at $103.2 B, or ~$118/share (08/03/16), the No-Growth value of MCD represents 86% of the market price,
meaning only 14% of the market price represents expected growth in value in the future.
The PVGO % represents about 5% CAGR over a 3 year investment horizon, or a 3% CAGR over a 5 year investment horizon.
The key question to ask again is are the implied growth rates of the market reasonable, too optimistic, or too pessimistic?
Remember, MCD is currently paying a 3% dividend yield due MCD’s overall franchising strategy and 15-19% margin for earnings and free cash
flow, essentially making the company a cash cow.
Based on these preliminary results, an investor may think the market expectations for growth are too pessimistic, and the dividend alone can
justify the growth expectations.
At a 5% Growth Rate
No-Growth %
86%
PVGO %
14%
$100 $16
Years 0 1 2 3
$101 $106 $112 $118
At a 3% Growth Rate
No-Growth %
86%
PVGO %
14%
$100 $16
Years 0 1 2 3 4 5
$101 $104 $108 $111 $114 $118
Update tables
19
20. Implications of MCD’s PVGO Status – Income Approach
Currently,research analysts are forecasting a 9-10% long-term annual growth rate for MCD, which equates to a 25-35% PVGO.
Based on this range, MCD could be priced anywhere from $135-$156/share in the next 3-5 years, or ~23% return at the midpoint.
Since long-term growth estimates are usually revised downward overtime, I will use these estimates as a best case scenario and observe past
trends and future plans for MCD to estimate a long-growth rate.
At a 10% Growth Rate
No-Growth %
75%
PVGO %
25%
$101 $34
Years 0 1 2 3
MCD Price $101 $112 $123 $135
At a 9% Growth Rate
No-Growth %
65%
PVGO %
35%
$101 $55
Years 0 1 2 3 4 5
MCD Price $101 $111 $120 $131 $143 $156
20
21. Implications of MCD’s PVGO Status – Income Approach (cont.)
After observing these current trends, I’m actually surprised that the market doesn’t have negative growth expectations for MCD. However, 45%+ annual
EPS growth, operating margin expansion, and continued dividend growth suggests that MCD’s growth initiatives are working, and the market believes so
too.
If EPS and dividend growth continues as even a modest pace, then MCD could potentially reach analysts’ long-term growth expectations.This is
especially possible if an investor believes the expansion of MCD’s all-day breakfast menu can sustain the growth.
From a bearish perspective, the ‘pop’ in EPS will only happen for the next quarter or two, as the all-day breakfast roll-out will lose momentum.
Additionally, MCD’s same-store sales could continue to decline as customers might not react well to MCD increase prices and having higher-quality
food.
Based on the information given and the corporate life cycle stage of the company, my long-term growth estimate for MCD will be 5-7%. This leads to
~20% PVGO based on my growth estimate and a price target of $124-$129/share, or ~8% return, 3-5 years from now.
Potential Growth Drivers
Year FY 2013 FY 2014 FY 2015 TTM
Number of Restaurants 35,429 36,258 36,525 36,504
Annual Sales Growth 2.0% -2.4% -7.4% -0.9%
Annual EPS Growth 3.5% -13.2% -0.4% 46.4%
Operating Margin 31.2% 29.0% 28.1% 29.7%
Gross Profit/Assets* 0.31x 0.29x 0.29x 0.28x
Capex/Sales 10.1% 9.4% 7.1% 7.2%
Dividend Growth 8.7% 5.1% 4.9% 3.6%
Source: SEC Filings, Morningstar, Individual Analysis
*GPA equals this year's gross profits divided by last year's assets
At a 7% Growth Rate
No-Growth %
82%
PVGO %
18%
$101 $23
Years 0 1 2 3
MCD Price $101 $108 $116 $124
At a 5% Growth Rate
No-Growth %
78%
PVGO %
22%
$101 $28
Years 0 1 2 3 4 5
MCD Price $101 $106 $112 $117 $123 $129
21
22. Implications of MCD’s PVGO Status – Market Approach
To get a better sense of MCD’s growth expectations relative to its peers, I’ll compute the PVGO % for other companies and potential growth
drivers, and compare the results to MCD.
Company
Market Cap
($M)
Market Price TTM EPS Beta
Size
Adjustment
Disc. Rate EPS/r
% No
Growth
% PVGO
3 Year
Growth
Est. via
PVGO
5 Year
Growth
Est. via
PVGO
LT Growth
Estimate
Sonic Corp (SONC) $ 1,370 $ 28.15 1.28 1.81 2.00% 14.88% 8.60 30.56% 69.44% 48.43% 26.75% 17.70%
Wendy's (WEN) $ 2,610 $ 9.70 0.52 0.69 2.00% 7.86% 6.62 68.24% 31.76% 13.59% 7.94% 14.87%
Jack in the Box (JACK) $ 3,360 $ 96.99 3.08 0.68 1.50% 7.29% 42.23 43.54% 56.46% 31.93% 18.09% 17.48%
Yum! Brands (YUM) $ 34,470 $ 88.42 3.32 0.96 0.00% 7.55% 43.98 49.74% 50.26% 26.22% 14.99% 12.18%
Dunkin Brands
(DNKN)
$ 4,120 $ 44.92 1.32 0.12 1.50% 3.78% 34.90 77.69% 22.31% 8.78% 5.18% 13.21%
Starbucks (SBUX) $ 81,310 $ 55.44 1.78 0.80 -0.50% 6.05% 29.44 53.10% 46.90% 25.27% 14.48% 18.13%
Average $ 21,207 $ 53.94 1.88 0.84 1.08% 7.90% 27.63 53.81% 46.19% 25.70% 14.57% 15.60%
Median $ 3,740 $ 50.18 1.55 0.75 1.50% 7.42% 32.17 51.42% 48.58% 25.75% 14.74% 16.18%
McDonald’s (MCD) $ 103,200 $ 117.52 5.24 0.66 -0.50% 5.17% 101.39 86.27% 13.73% 5.08% 3.01% 9.00%
% Prem. (Disc.) to
Median
2759.36% 234.20% 338.06% 88.59% -33.33% 69.64% 315.17% 167.78% 28.25% 19.73% 20.43% 55.64%
Source: SEC Filings,Yahoo Finance, Individual Analysis
22
23. Implications of MCD’s PVGO Status – Market Approach (cont.)
Based on the peer group, it looks as if McDonald’s
is much more along in the corporate life cycle
(CLC) based on the number of restaurants and
market capitalization. This also explains why gross
profits to assets, PVGO % and long term growth
estimates are less than the peer group.
Being further along the CLC, McDonald’s doesn’t
have as many investment opportunities as the rest
of their peers, so the best way to maximize their
value is to minimize the discount rate.To achieve this,
MCD has controlled their expenses, leading to a
higher operating margin, as well as paid a higher
dividend, leading to a higher dividend yield.
Given the past sales growth and capital
expenditure levels of MCD were similar to their
peers, I believe the higher margins can lead to
higher growth than what is being baked into their
stock price, relative to the peer group. Based on
this analysis, I reiterate my belief that MCD’s
PVGO % should be closer to 20-25%.
Company
Number of
Restaurants
TTM Sales
Growth
TTM EPS
Growth
TTM Operating
Margin
TTM GP/Assets TTM Capex/Sales
TTM Dividend
Yield
Sonic Corp (SONC) 3,512 0.3% -18.4% 20.6% 0.39x 6.1% 1.6%
Wendy's (WEN) 6,482 -18.8% 28.6% 16.7% 0.17x 12.8% 2.5%
Jack in the Box (JACK) 2,910 2.6% 28.2% 13.7% 0.34x 6.8% 1.2%
Yum! Brands (YUM) 42,000 -3.1% 52.8% 16.1% 0.43x 7.0% 2.1%
Dunkin Brands (DNKN) 19,669 2.3% 22.7% 40.5% 0.20x 2.8% 2.6%
Starbucks (SBUX) 17,000 7.3% 24.4% 19.1% 0.92x 6.8% 1.4%
Average 15,262 -1.6% 23.0% 21.1% 0.41x 7.0% 1.9%
Median 11,741 1.3% 26.3% 17.9% 0.37x 6.8% 1.8%
McDonalds (MCD) 36,504 -0.9% 46.4% 29.7% 0.28x 7.2% 3.0%
% Prem. (Disc.) to
Median
310.9% -69.0% 176.6% 166.0% 77.6% 105.1% 164.3%
Source: SEC Filings, Morningstar,Yahoo Finance, Individual Analysis
23
24. Implications of MCD’s PVGO Status –Valuation Range
It is also possible to construct a sensitivity table for the various PVGO % and discount rates for the price for MCD.
Based on this table and my estimates, I could potentially make a case that there’s more upside potential for than downside for MCD.
$126.74 4.17% 4.67% 5.17% 5.67% 6.17%
10% $139.68 $124.72 $112.65 $102.72 $94.39
15% $147.90 $132.06 $119.28 $108.76 $99.94
20% $157.14 $140.31 $126.74 $115.56 $106.19
25% $167.62 $149.67 $135.19 $123.26 $113.27
30% $179.59 $160.36 $144.84 $132.07 $121.36
PVGO %
Discount Rate
MCD Price Sensitivity Table
24
25. PVGOThought Process for other Companies
After understanding how the PVGO Thought Process was used for MCD, lets try to find anymore insight
from just looking at the Economic Benefits, Discount Rates, implied 3-year and 5-year implied growth rates
from the PVGO Thought Process, and the long term projected growth rates by equity research analyst.
An investor can quickly screen for investment ideas by just comparing the implied rates to the long term
rates projected by the research analysts to see if the projected long term growth matches what’s implied by
the PVGO %.
For the cells in the next 2 tables:
Green – Research analysts’ growth projections are greater than the implied growth rates from the PVGO %
Red – Research analysts’ growth projections are less than the implied growth rates from the PVGO %
Non-Color – Research analysts’ growth projections are in between the implied growth rates from the PVGO %
25
27. Implications of PVGO Status – Large Caps
For most companies, their betas are less than one, meaning these larger companies are expected to be safer
than the overall market.This is also the main factor for companies that have long term growth rates their
PVGO % range.
If the forecasted long term growth rates did not fall into the PVGO % growth range, it wasn’t too far off.
For the cases with large discrepancies between what analysts project for long term growth and what PVGO
% observes mostly stems from companies that have negative growth expectations. Some companies with
higher projected growth rates from research analysts (>20%) tend to be overvalued, as their PVGO % is
extremely high.
Source: SEC Filings,Yahoo Finance, Individual Analysis
27
29. Implications of PVGO Status – Small/Mid Caps
The small/mid caps have betas above one and higher size adjustments, which led to discount rates higher than
10% for most companies.
Once again, the companies that have forecasted long term growth rates above the derived PVGO % range
stems from low to negative growth expectations.
In terms of gross cash flow, there tends to be a larger discrepancy between research analysts’ growth
forecasts and growth expectations derived from PVGO % when compared to large caps.This leads to the
belief that understanding small/mid cap companies can potentially lead to abnormal returns for an investor.
This idea also plays into the “illiquidity/relevancy premium”, where stocks with little to no media coverage and lower
trading volumes can provide the best opportunities to beat the market.
Source: SEC Filings,Yahoo Finance, Individual Analysis
29
30. Key Drawbacks to PVGOThought Process
Although the PVGO Thought Process can lead to interesting insight about the growth expectations for a company,
there are a few drawbacks and pitfalls to watch out for:
1. An economic benefit that yields a positive number must be used in order to determine the PVGO % (see GoPro valuation
on slide 27 for example).An investor must also know which economic benefit to use when valuing companies at various
stages of the corporate life cycle in different industries, especially when yielding extremely high or negative growth
expectations. Since FCF and EPS cannot always be used for every situation, an investor must understand how the economic
benefit will lead to value creation over the given time horizon.
2. The discount rate is the only true way to account for risk, so an investor must have a clear understanding as to how to
calculate it, as well as make adjustments for different fundamental factors.Also, an investor must determine if the benefit
used will be for all shareholders and debtholders or shareholders only, because this will affect the discount rate used.
3. The PVGO Thought Process is best used when an investor has a target time horizon. Based on implied market discount
rates, the typical market participant invests with a time horizon between 3-7 years.The process isn’t as effective if an
investor’s time horizon isn’t in between these parameters because if the time horizon is shorter, than only stock with
negative expectations will be deemed investible ideas. Conversely, an investment horizon beyond this range may yield too
many investible ideas. 30
31. Conclusion
The PVGO Thought Process can be used as an attempt to quantify the market’s growth expectations for a stock.
Can lead to higher accuracy in forecasting economic benefits and understanding investor sentiment for a
company’s stock in a short amount of time.
Can also be used to understand what stage the market may think a company is at in their Corporate Life Cycle.
This process is best used for investors that fully understand the major inputs:
1. Economic Benefit
2. Discount Rate
3. PVGO % of the company relative to it’s own history and peers
4. An investor’s time horizon
31
32. Key Resources
Expectations Investing: Reading Stock Prices for Better
Returns by Michael J. Mauboussin – CFA Publications
(September 2006)
Fundamental Analysis and Market Prices Presentation for
the OIV Conference by Stephen Penman
Aswath Damodaran’s website and publications
New Construct’s website
Valuation: Measuring and Managing theValue of
Companies: Fourth Edition – byTim Koller, Marc
Goedhart, and DavidWessels
Understanding BusinessValuation – by Gary R.Trugman
Jae Jun from Oldschoolvalue.com
Duff & Phelp’s Cost of Capital Series
The Guru Investor by John Reese
Best Practices for Equity Research Analyst and
AnalystSolutions website by JamesValentine
Morningstar’s website
Zack’s website
Marketwatch’s website
Barron’s website
Federal Reserve Economic Data
S&P Dow Jones Indices
32
![Keynes’s Famous Beauty Contest Quote For The Stock Market
"It is not a case of choosing those [faces] that, to the best of one's judgment, are really the
prettiest, nor even those that average opinion genuinely thinks the prettiest.We have reached
the third degree where we devote our intelligences to anticipating what average opinion
expects the average opinion to be.And there are some, I believe, who practice the fourth, fifth
and higher degrees.“
Keynes, GeneralTheory of Employment, Interest and Money, 1936
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