4. Signs the market has already changed its mind
Level 4: What really moves the price
This is the most uncomfortable module of the level. Everything so far has been about spotting when an expectation gets revised. The worst part is still to come: it is almost always revised before you find out. A correct idea that arrives after the revision is not a correct idea running late, it is a wrong idea, because you are buying a bar that has already been raised.
Arriving late does not look like being wrong
When you are completely wrong, you notice: the thesis does not play out. Arriving late is more treacherous, because the thesis does play out. The company does exactly what you said it would, the results prove you right, and the share does not move, or it falls. That happens when the expectation holding the price up already contained your thesis at the moment you bought. You get paid the difference, and the difference was zero.
That is why the work does not end with being right about the company. You have to be right about the company and, at the same time, estimate what the market already believes. And there are three signs that give away that the market has already changed its mind.
Sign one: the price moves with no news
A share that rises or falls 15% over several weeks with no announcement, no results and no change in its sector is saying something quite clearly: somebody is revising the path with information, or with a reading of it, that you do not have. The literature on reactions to announcements spent decades observing that a good part of the move associated with a set of results happens in the days before publication, not on the day of the announcement.
The point is not to suspect anybody of anything. It is to grasp the practical implication: when the news finally comes out and the share barely moves, it is not that the news was irrelevant, it is that it had already been paid for. Confusing those two things leads to conclusions that are exactly the wrong way round about what the market cares about.
Sign two: the asymmetric reaction
This is the most useful of the three, and the easiest to observe without any tools. Watch several consecutive pieces of news from the same company and compare:
- Good news that barely moves the price, bad news that sinks it. The bar is already sky-high: the good is priced in and all that is left is room to disappoint. It is the signature of a demanding expectation.
- Bad news that barely moves the price, good news that sends it flying. The bar is on the floor: the bad news was already in the price and any improvement is pure surprise.
- A symmetrical, proportionate reaction. The expectation is reasonably centered, and there your analysis of the business really can pay.
Asymmetry measures something no set of annual accounts contains: which way the expectation is skewed. And you can read it for nothing, by looking at how the share reacted to the last four or five pieces of news.
Sign three: the multiple compresses while profit rises
The third sign is the one that costs the most money to ignore. A company reports rising profits year after year, and the share goes nowhere. What is happening is multiple compression: each year the market pays fewer euros for each euro of profit, because it has been cutting its expectation for future growth while present profit went up.
With numbers, to see it. A company earns 1,000 million and trades at 30 times earnings: it is worth 30,000 million. Five years later it earns 2,000 million — it has doubled — but the market now pays only 15 times: it is worth 30,000 million. Profit has doubled and the shareholder has not made a euro. There was no bad news. There was a silent, continuous revision of the duration of the growth, made in installments, without a single headline to announce it.
This is the case where the accounts and the price tell opposite stories, and where anyone looking only at the accounts concludes that the market has got it wrong. It is almost never wrong about the direction: the market is saying that this profit will grow for fewer years than was believed.
What to do with this without ending up paralyzed
None of the above means it is impossible to make money. It means the right question changes. Instead of asking whether the company will do well, ask yourself:
- What would have to happen for today's price to be cheap? If the answer is something already in every headline, you are late.
- Is my thesis different from the consensus one, or just more enthusiastic? Agreeing more keenly is not an edge.
- When was this expectation last revised, and why? If you cannot answer that, you do not know what you are paying for.
A real case: doubling profits and making nothing
The classic example of multiple compression is Microsoft between the end of the nineties and the early 2010s. The company kept growing revenue and profit throughout that period, on very high margins and with no operating disaster. And yet a shareholder who had bought at the highs of the year 2000 spent more than a decade without getting their money back. The multiple went from very elevated levels, on the order of several tens of times earnings, down to single-digit levels or not much more. Take those figures as magnitudes rather than as exact data.
A similar pattern showed up in the large US retailers during the 2000s: sales and profits rising steadily, share flat for years, multiple falling without pause.
In neither case was there a piece of news that explained it. There was something harder to see and a great deal more expensive: the market had stopped believing that growth would last, and it had been saying so for years in the only language it uses, which is the price.