Tag: Valuation

Value vs Growth

If you follow the financial media and the media coverage around stock markets on topic that repeatedly pops up is the Value vs Growth debate. Apparently, Value has underperformed Growth for many years now and some have even gone so far as to declare Value Investing dead.

Why Value Investing is indeed Dead

I also think that Value Investing is dead, but not for same reasons that the pundits do. The general conception of the value is dead logic is that:

  1. The market is much more efficient now and the competition within value investors is fiercest. This drives away any pricing opportunities sooner that it used to be.
  2. The internet and globalization has created an environment with more extreme scaling effects and power laws. This results in winner-takes-it-all situations where one or two players dominate the market and take in all the profits.

The conventional value invest retort is that value is relative to price. That is, that a good company is not a good investment at any price. Value investors also tend to believe that the move into passive investing has favored companies that are considered growth companies at the cost of companies that would be considered value stocks.

What is the opposite of Growth Investing?

My logic for declaring Value Investing dead, is that Value Investing never existed in the first place. Value Investing and Growth Investing are both fundamental investing methodologies. Both strategies are looking at fundamental factors (revenues, earnings, cash flows) and estimating the current value from those factors.

But is value the opposite of growth? If Growth Investing is about discovering and investing in companies that are growing fast and that this growth underestimated in the current value of the stock. You could say that growth investors are of the opinion that the market over-discounts the value of future profitability of high quality growth companies.

The opposite of Growth Investing would be to discovering and investing in companies that are deteriorating but that this deterioration is overestimated in the current value of the stock (and/or higher up in the capital structure). The opposite of Growth Investing, in my humble opinion, is Distressed Investing.

Distressed investing is Value Investing. But Growth Investing is also Value Investing, because all Value Investing is just Fundamental Investing.

Value and Growth are Joined at the Hip

Most people think Warren Buffett is a value investor but if you want to go into the particulars, one could argue that he is primarily a fundamental investor. Buffett famously said that growth and value are joined at the hip. Both are areas of fundamental analysis.

One could also argue that many business owners would not easily understand the question if you would ask if they focus more on growth or value in their capital allocations. Business owners simply allocate capital to the projects with the highest expected IRR, irrespective of any category you might want to fit it into. 

Personally, I really like the framework put forth by the late Marty Whitman. In his opinion, there are are 5 main areas of fundamental finance: 

  1. Value Investing (limited to minority positions in public co’s) 
  2. Distress Investing
  3. Control Investing
  4. Credit Analysis
  5. First and Second Stage Venture Capital Investments

Warren Buffett, as an example, has been active in all of those categories, either directly or indirectly. Henry Singleton, as well, is someone you could not classify as a value investor specifically. He just went where he thought the highest IRR was at any given time.

If you’ve seen one financial crisis, you’ve seen one financial crisis

The title of this post is a quote from former Fed governor Kevin Warsh. It’s reminiscent of the line from Tolstoy’s Anna Karenina that says happy families are all alike but every unhappy family is unhappy in its own way.

At the same time, our behavior is highly mimetic. Not only do we base most of our learning on imitation, but we are constantly searching for clues by comparing the current to the historic. I do this myself, literally all the time. 

When I’m looking at potential investments or trying to value stuff, I find myself searching for historical comparisons. When looking at XL Media, I immediately connected it with American Express and the famous Salad Oil Scandal. When I looked at CentralNic, I started drawing comparisons between the domain industry and cable industry in its early days.

Performing these mental model checks and looking for similar histories, is the default setting, in my experience. It seems to happen almost automatically. I need to force myself to not do it. It is in our nature. It’s a survival thing (see, I just looked for a comparable mental model and found evolutionary theory…).  

The Implied Meaning of a Market Cap

“Apple is worth $2,000,000,000,000. That is a lot of money” said Anthony Pompliano on Twitter the other day. Dave Collum promptly corrected him: “priced at.” This is a very important and warranted distinction. We talk about the market capitalizations of companies all the time, but less often we think about what it actually implies. 

For Every Buyer there is a Seller

The current price of a publicly traded stock is the most recent point where the most willing seller and most eager buyer matched. So when Apple stocks ended a trading day at $498, the last buyer and seller that were matched were willing to do business for that price. For someone to buy, someone also has to sell. 

But the market price only gives us some information about the marginal sellers and buyers. One an average day, somewhere between 100 to 200 million shares of Apple stock will change hands. That’s a lot of shares. On particularly busy days, this will exceed 300 million. On a slow day, however, as little as 50 million shares will change hands. But Apple has 4.35 billion shares outstanding. So, even on the most hectic days, less than 7% of the outstanding shares will change hands.

The 7% figures is likely deceptive as high frequency trading and other forms of day trading and market making might overstate the fact that the majority of stockholders will not sell on a given day. 

Therefore, the market cap and stock price of a company will tell you where it is priced at by the market. it won’t tell you where the stock is valued at by the market.

Strawman & Steelman Valuations

A strawman argument is a frequently used tactic in rhetoric and oratory debate. It’s used in business, in politics and Twitter arguments alike. It’s simple and effective. You basically pick an argument of your opponent and rephrase it in a way that makes it easy to refute. Strawman arguments are not real arguments. They don’t even have to be true. 

Peter Thiel argues that for decision making, you should really steelman your opponents arguments. If you try to find the strongest and most compelling reasons for your opponents stand, it allows you to improve your side of the argument or even discover flaws in your own reasoning. 

The same should apply to valuation. You should always try to steelman the potential risk factors that you apply to your investment thesis. 

How to Value a Brand?

The intriguing thing about brands is that they are mostly intangible. You generally won’t find the brand value of a company on its balance sheet. As an example, the $90 billion that Coca-Cola has spent on advertising in its history has no value that is shown on Coca-Cola’s balance sheet. Nonetheless, the brand value clearly is there. The market value of Coca-Cola’s common stock is ten times that of the stated book value of the equity. 

So how do we value a brand? The problem with a task like trying to value a brand is that there will always be some form of circular logic in this kind of exercise.

Is Coca-Cola such a strong business because it is built around such a strong brand, or is Coca-Cola such a strong brand because it is built around such a strong business? 

Where is the boundary where the value from the business model stops and value add from the brand begins? Is it even possible to separate those two things from each other? Brands are contextual. If you could buy the brand out of Coca-Cola, Inc and pivot it to sell Coca-Cola branded furniture, value would most definitely be destroyed. 

Brand Valuation Frameworks

As it turns out, ISO – the International Organization of Standards – has formulated a standard on Brand Valuation. You can even find an old version of the standard online.

Interbrand we the first company to get a certification for standard ISO 10668, the standard for Brand Valuation. Interbrand publishes an annual list of the most valuable brands in the world. You can read more about the Interbrand brand valuation methodology here.

Brand Valuation Resources

Something more to add? Let us know in the comments section!

This is the biggest mistake value investors make

Value Investing is seductively easy. Summarized into one sentence, Value Investing is the art of picking stocks that are undervalued, a.k.a. buying a dollar for 50 cents.

Tempting, right?

The big problem – paraphrasing what Johan Cruyff said about football – Value Investing is a simple concept, but it is extremely hard to invest with simplicity.

How Value Investors Buy Books

Consider the following analogy:

Put yourself in the shoes of a Value Investor in a book store. Having a natural inclination to buy stuff that is undervalued, you will automatically be drawn to the table with a big sign saying:

  • Books 50-80% OFF! 

…and therein lies the problem.

Buying a book is a bet with an asymmetric outcome. The downside is that you will buy a book and it might turn out to be a waste of your time, plus the $10 to $30 it cost to purchase it. The upside, however, is close to infinite. A good book can fundamentally alter your life.

Coffee consumption is another good example. If you could only drink one cup of coffee a day, you would probably not drink the first cup of joe available to you. You would be more selective. You might even be willing to pay more for the right one.

Mistakes of Omission

Most of the books on the discount table are crap. They are there for a reason.

The Value Investor, focused on the table of discounted books, might end up finding a book that is good enough to be worth the purchase.

At the same time, his attention is turned away from the books that can truly alter his life.

Do you disagree? Let us know in the comments below!

The Columbo Method of Equity Research

Remember detective Columbo? He was a phenomenal character played by Peter Falk in a 1970s TV series called…you guessed it…Columbo. Detective Columbo was a scruffy and simplistic character, dressed in his signature beige raincoat and crumpy white shirt with a loosely knotted tie.

Colombo is no normal detective series, though. As is you would expect, Columbo’s job is to solve murder mysteries. However, the episodes don’t play out with Columbo delving into each case and eventually discovering who is the murderer, in a sharp twist near the end. Columbo is a detective series without the mystery.

In the case of Columbo, each of the 69 episodes begins with the scene of the murder. So, as a viewer, you know from the beginning who the doer is. The rest of the episode is a mental wrestling match between the murderer and lieutenant Columbo.

The Colombo Technique of Investigation

In each Columbo case, the murder is committed by someone close to the victim. This allows Columbo to approach the suspect as a witness or someone who can help Colombo in piecing together the pieces of the puzzle.

To the assailant, Columbo seems totally incompetent. The scruffiness of his hair and clothing give the impression that he slept in his clothes. He constantly scratches his head and he asks the assailant for help. His questions are simplistic and make him look like he’s totally out of his dept.

But Columbo is playing a part. He’s playing dumb. The perpetrator grows confident and starts to get comfortable, even annoyed. The trap is set. In the final minutes of a Columbo episode, the perpetrator has made a mistake and Columbo wrestles him down for the tap-out.

Stock Research and Colombo 

So, how does this relate to equity analysis? In stock research, there is no crime, there is no murderer. As an analyst, you have a stock and you build your opinion based on fundamental analysis.

But therein lies the caveat. You see, it is you who is the perpetrator because once you start your analysis, you start to for opinions. You will start subjecting your mind to all forms of mental biases. You become overly optimistic. You get anchored. You will start to look for confirmation in the data.

“But that’s me, I’m paranoic. Every time I see a dead body I think it’s murdered. Can’t imagine anyone murdering themselves.”  

– Lieutenant Columbo

As an analyst, you have to put on your mental raincoat and find your inner Columbo. You have to take a step back and start to ask yourself the simple question. The overly naive and borderline stupid questions. You have to confront yourself and find start to look for loopholes in your story.

Just One More Thing…

Lieutenant Columbo bombards his suspects with questions. He’s relentless. He keeps coming back with a question. He’s apologetic, he excuses himself. He just can’t help himself, he says. But he keeps coming back for “just one more thing.” 

Discount to Net Asset Value | Protect Your Downside

One way to value a stock, especially those of companies that own various subsidiaries or a portfolio of assets, is by analysing the company’s discount (or surplus) to Net Asset Value.

Conglomerate Discount – The Case of Exor

We recently took a close look at Exor N.V., the holding company that controls such publicly traded companies as Fiat Chrysler Automobiles, Ferrari and CNH Industries. Conglomerates like Exor are interesting to analyse as they tend to trade a steep discount on the mark-to-market Net Asset Values (or market-adjusted book value).

In the case of Exor, the company trades at about a 30% discount on the market value of assets on the balance sheet. 

Point of Maximum Pessimism – The Case of Dundee Corporation

If you are a Contrarian Investor, you are trying to go where other investors feel extremely uncomfortable to be. You are trying to go where others are running to the exits, but at the same time, you don’t want to be too early. 

One of those situations is materializing at a Canadian Asset Management Company called Dundee Corporation. After a series of unfortunate events (and decisions), the market capitalization of Dundee is gone from about a billion dollars to about $74 million. 

The company trades at a steep discount to book value, but for good reason. The company has been haemorrhaging money as failed investments have sucked up cash and destroyed shareholders’ capital. 

But investors may have overreacted. Even though the company is taking drastic steps to turn the business around, Dundee’s stock is trading at about a 70% discount to book value. If the company manages to stop the bleeding, a significant re-rating might be in the cards. 

The Fundamentals are in the Footnotes

The whole point of fundamental research or value investing or whatever you want to call it is to get an edge by looking a little deeper than others are looking. This is why you won’t get very far by using stock screeners.

Stock Research on Onverstock.com 

We recently published a stock report on the Fundamental Finance Playbook about Overstock.com. The article is a deep dive into the current status of the company’s online retail business. We try to figure out if the business is, in fact, in a turnaround as management claims, or if the company is at risk of running out of cash.

Previously, the management had stated that they were trying to sell the online retail business but so far nothing has materialized. During our research phase we noticed that during the last quarter, consulting fees on the corporate level had increased significantly. By corporate level, we mean not connected to the operations of the online retail business nor the blockchain ventures.

Overstock engaged Guggenheim in 2018 to explore strategic options for the retail business and find possible buyers. If the consulting expenses are mostly in the “Other” business segment and neither in the retail operations nor the tZero operations, it is plausible that Overstock is already in advance negotiations with potential buyers through Guggenheim.

What that indicated to us, was that there was a possibility that Overstock was already working with Guggenheim Securities, the company that Overstock employed to find buyers, on advanced negotiations with possible buyers. These kinds of transactions usually require heavy due diligence, so it would be quite plausible that costs would ramp up like this.

Two Potential Acquirers 

A week after we published, Patrick Byrne, Chairman and CEO of Overstock said in an interview with CNN that the company was in negotiations with two potential acquirers. It remains to be seen if anything materializes from this, but it goes to show that sometimes the fundamental facts are buried in the footnotes.