Believable?

We’re starting a series of research projects called “The Prepared Mind”. We borrowed this monicker from one of our favorite Mungerisms:

“Opportunity meeting the prepared mind; that’s the game.”

This is the first of The Prepared Mind series. We’re preparing for a significant market correction – say in the 10-15% range – in the next few months. We don’t know when it will happen, or even whether it will happen. But we need a ready-to-pounce, well-researched list of investment candidates.

Recently, we’ve been on a roll with the principles of Expectations Investing – this turns the art and science of valuation on its head. It answers the question: “what do you need to believe about the underlying business to buy this stock?” We use this approach for our Watch Lists. We applied this to the Big 4 in Social Media (we’ve left out LinkedIn because it’s owned by Microsoft, whose base business is not advertising).

Just based on this table, Facebook is the clear winner. In other words, we need to believe with reasonable confidence that Facebook’s revenue will grow 70%, cumulatively, over the next few years. That’s the most reasonable assumption in this table. The other stocks look richly valued – we’d need to believe a lot more to buy into their story. But it’s not as simple as that. Maybe the other companies have a lot more upside in their story than Facebook does.

In the next few sections, we’ll break down the numbers and get into their stories.