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What's Baked Into a Stock Price?

What's Baked Into a Stock Price?

Holly: Our two bakers, Karen and Julie, are very excited today. They each think they have perfected the recipe for knowing the true value of one of the hottest stocks on the market today. Driven Drive-in, a drive-in movie theater stock that has been up 300% in the last two months. But what have they really found out about Driven Drive-in's true flavors? Let's check in with the bakers to see what they have to say. First, we'll start with Karen. Karen, what have you got cooking there?

Karen: So glad you asked. I have a combination of truly excellent factors. I found out about Driven Drive-in's stock on Eat-It last week.

Holly: Eat-It?

Karen: Oh, you don't know Eat-It? It's like, the front page of the baking Internet. Anyway, Drive-in, so kitschy but fun, right? They just announced that they're doing this collaboration with that one gluten-free popcorn line and that cookbook author who's married to that singer... I can't remember, but I forgot the name. Oh, but the popcorn tastes exactly like popcorn. You would never know that it's gluten-free.

Holly: I believe all popcorn is naturally gluten-free.

Karen: Well, anyway. The stock is less than $5 a share, so it's cheap. Right? I bought a ton of shares. The price has gone up from $2 to $4 since that popcorn collaboration was announced. I just feel like I can't go wrong, really.

Holly: Well, all right. Can you tell us about your recipe?

Karen: Well, OK, so, I mean, everybody wants to buy the stock, and then the people who don't already own the stock are talking about how they want it buy it...

Holly: But what goes into your stock baking? What are the ingredients?

Karen: What do you mean? It's all in here. You go to the market, and you buy whatever it costs, and then you just dump it in the bowl.

Holly: It looks like you've just filled the baking tin up all the way to the lip with batter. You haven't even bothered to grease or flour the pan.

Karen: Nope. I'm all in. I wanted to jump in and buy the stock before the price went up even more.

Holly: OK, then. Let's turn to Julie. Julie, it looks like you're taking a bit of a different approach there. What are you cooking up?

Julie: Whatever Karen may think, I think that stock baking is more of a science than an art. I took a really purposeful approach to looking at each ingredient and why I'm choosing to add it to my batter here. I first took a look at one ingredient, which was the total addressable market size for Driven Drive-in. You can see here. This is the total addressable market. But I only put a portion of this into my batter because I think there's no way that Driven Drive-in could take all share from competitors, whether it's regular movie theaters or even other sources of entertainment, like video games.

I, then, mix this in with a little bit of operating margin expansion. Just a little bit went a long way in increasing the fair value estimate for my stock cake. But I think that there's margin expansion for the company. I think that this is the case because if you think about it, drive-in movie theaters are really a premium experience compared to regular movie theaters. They appeal to that nostalgia. I think that, eventually, Driven Drive-in could increase their prices. They don't have to stay at the regular prices that traditional movie theaters are charging right now.

Then, I added in a little bit of weather-related vulnerabilities for Driven Drive-in. I think when you think about Driven Drive-in's business, it's outdoors. They can't be in business every day, and that's going to take from their ultimate value in the long run.

Then, after mixing those all together, I added a narrow moat rating with a positive moat trend here. That's really because I think that the company has an intangible assets moat source based on its brand perception. I think when we think of drive-in movie theaters, we think of Driven Drive-in. I think that that special moat source will give the company excess returns on invested capital for the next 10 years.

Julie: Then, I added in the tax rate that I think the company will endure over the long run. Here and there, I added in some other risks for the company--let's say, if traditional movie theaters got into the business.

Holly: There's a lot of wholesome ingredients so far. Anything to offset all this optimism?

Julie: Well, I then baked the batter at a WACC temperature of 7% based on the cost of equity and the cost of the debt for Driven Drive-in. At this temperature, I put it in the oven for approximately a time of forever because I do think that's how long this company will be around for. That's how I got my pièce de résistance.

But let me let you in on a little stock baker's secret. It's very important to note what I didn't add in to my batter. Firstly, I didn't add any regulation risks into my batter, and that's because I think that the possibility that the government would regulate the drive-in movie industry is very slim. Secondly, I never added in any potential alternative revenue streams for Driven Drive-in--for instance, if Driven Drive-in rented out cars to be used at their drive-in theater, because I think that people would be very unlikely to rent a car for that experience. Because the stock I baked came out of the oven at a fair value estimate that was less than the pan size of the market, which is about the size of Karen's cake, I chose not to buy into this cake and buy the stock.

Karen: But how can you not? It's so cheap. I don't get it.

Julie: Well, actually, the stock isn't cheap according to my recipe, Karen. You're actually conflating price with cheapness. But really, the price of a stock is all relative to how many shares are out there as well as your fair value estimate for the company as a whole. It's all about how you slice it. When I slice my stock cake, you can see that given the eight shares out there that my fair value estimate for the stock cake is actually $3 per share, whereas yours is $5 per share and therefore much more expensive.

Holly: It looks like the moral of the story is: Don't assume pre-made cake stock mix is right, and don't always trust what you read on the Eat-It blog. Estimating a true fair value estimate or "flavor value estimate," as I like to say, for any stock, takes a lot of care.

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