Picking Your Hunting Ground
“Basically all investment is value investment in the sense that you’re always trying to get better prospects than you’re paying for. But you can’t look everywhere at once, any more than you could run a marathon in twelve different states at once. And so you have to have some system of picking some place to look, which is your hunting ground.”
There is no virtue in dogmatically clinging to an approach that no longer works. And lately, the chorus of voices proclaiming the death of value investing has grown much louder. The familiar case against value investing is that it is hopelessly backward looking and, by insisting on quantifiable measures of the past, is destined to miss all of the big shifts in technologies of the future.
This charge is nothing new, of course. But the COVID-19 pandemic has illustrated how quickly the world can change and how new business models, driven by technology, can rapidly upend established industries. Intangible assets, long derided as somehow not “real” by many value investors, have proven not only resilient but essential in an environment where economic activity in the physical world has become more challenging.
The reality is that the best value investors have never been as dogmatic as the stereotypes suggest. Philip Fisher and Ben Graham both experienced the Great Depression which shaped their outlook and investment philosophies. Fisher is known as a pioneer in the field of “growth investing” whereas Graham is considered the father of “value investing”, but Warren Buffett is a disciple of both Graham and Fisher. Value investors can certainly emulate Buffett and learn to apply Fisher’s investment principles.
Aswath Damodaran is a Professor of Finance at the Stern School of Business and recently published a three part series looking at the future of value investing. He starts with looking at the back story of how value investing originated and evolved, followed by an analysis of the recent tough times experienced by practitioners of the approach, and finally concluding with how value investing needs a new paradigm for a changing world. He concludes that value investing has lost its historical edge:
While some in this group [value investors] see this as a passing phase or the result of central banking overreach, I believe that value investing has lost its edge, partly because of its dependence on measures and metrics that have become less meaningful over time and partly because the global economy has changed, with ripple effects on markets. To rediscover itself, value investing needs to get over its discomfort with uncertainty and be more willing to define value broadly, to include not just countable and physical assets in place but also investments in intangible and growth assets.
Damodaran’s points regarding intangible assets are particularly important. Value investors who insist on restricting their investments to companies available at modest multiples of tangible book value automatically exclude from consideration some of the greatest growth stories of the current century. Being willing to examine the value of intangible assets is not an abandonment of value investing, it is simply adapting a conservative approach to recognize that intellectual property, customer relationships, and other intangibles can be just as important as plant and equipment, and in some cases far more valuable.
An honest assessment of my own decisions over the past decade shows that I missed many opportunities by being too dogmatic. In The Value Investor’s Technology Dilemma, written over a decade ago, I recognized the potential value of intangibles but essentially punted on trying to grapple with valuation of such businesses myself, instead opting to focus on stocks trading at modest multiples of tangible book value. It is not that I failed to understand intangibles and the moats that they often represent, but I felt that such companies were not within my circle of competence.
There is nothing wrong with being merely average when it comes to investing if you are adopting a passive approach. But if you are actively trying to beat the market, you need some sort of edge. Individual investors have a structural edge over professionals because they do not have to explain short term results to investors. But individuals rarely have an edge when it comes to analyzing reams of raw data. The types of cheap stocks Ben Graham found by sifting through dusty filings are now available to every investor at the click of a button. Statistical cheapness alone is no longer a competitive edge.
Returning to Charlie Munger, he has often said that investing is “not supposed to be easy. Anyone who finds it easy is stupid.” Why should it be easy to achieve market-beating returns? Those of us who attempt to do so, whether we call ourselves value investors or growth investors, need all the edges we can get. Increasingly, the edge might come from correctly analyzing the value of intangible assets.
Value investing is an intellectually sound framework but it is not a religion. In order to be useful as a means of making money, it must adapt over time. This is not throwing in the towel but acknowledging reality. Ben Graham died in 1976 so we cannot know how he would have adapted to today’s environment, but it is likely that he either would have adapted or he would have opted to index his investments passively. He was always intellectually curious and shunned dogmatism, and so should we.
The Election of 1948
This newsletter was written before Tuesday night so I have no idea who won the presidential election or if a winner will be declared by the time you receive this newsletter. However, there seems to be a lot of commentary regarding how a delay in learning the results is somehow unprecedented. In fact, many election results have not been known on election night or the next morning. The Bush vs. Gore election of 2000 is the most obvious example within the memory of most people living today, but the election of 1948 was notable as well.
Sean Connery (1930 – 2020)
Sean Connery died on October 31 at the age of 90. Connery was most famous for his role as James Bond but his talents defied being typecast as Joe Morgenstern describesin a thoughtful obituary. However, Connery was always my favorite Bond actor. Here is the famous laser scene from Goldfinger which was released in 1964:
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