There is no question stock prices climb and fall based on investors’ current perceptions of their future performance.

Identify an error in those perceptions; you, as an investor, have uncovered a catapult to superior performance. In Expectations Investing, Alfred Rappaport and Michael J. Mauboussin argue current stock prices express investors’ collective expectations. A change in those expectations lies at the heart of investment success.

This is a tall task. Approximately 75 per cent of all active investors deliver returns below those posted by passive index funds. The authors argue poor performance is built on a foundation of poor tool selection, high costs, and short-term vision and style limitations.

They argue investment performance can be improved by following three simple steps:

1. Estimate Price-Implied Expectations. Forget earnings and cash-flow estimates. Long-term discounted cash-flow models market performance.
2. Identify Opportunities. Expectation changes lead to changes in market evaluations. Whether you are looking at innovative technology or value, developed or developing markets, new or old economies, these principles are universal.
3. Develop a Disciplined Buy, Hold or Sell Strategy.

The ramifications of this discipline are they remove three misconceptions from investment thinking:

1. The market is short-term.
2. Earnings per share dictate value.
3. Price-earnings ratios determine value.

This well-written and thought provoking book harnesses the market power of discounted cash flow without requiring difficult and dubious long-term forecasts. It helps the serious investor develop a theory of where he or she is headed, why and more important, the courage to ignore advice that has nothing to do with underlying value. ( )