On the bookshelf in our hallway there resides a thick tome with a brown dust sheet, the pages tidily aligned and unthumbed, indicating one of many books bought with good intentions to read and educate but where that intent has not been fulfilled. The snappy title of this read is ‘Security Analysis, the classic 1934 edition by Benjamin Graham and David Dodd’.
My eyes were drawn to the book after reading one of the leaders in this week’s Economist – ‘Asset Management Beyond Buffet’[1]. The Economist argues that the framework that asset managers use to assess the worth of companies may need an upgrade to reflect changes in the digital age. In particular, the newspaper argues that such assessment needs to ‘…reflect an economy in which intangibles and externalities count for more.’ They note that intangibles – reflected as an expense on the income statement – are underappreciated from an accounting perspective given the scope for translation into future assets. The externalities to which they refer include the potential for future carbon taxes to impact the profitability of businesses that are currently able to emit without financial penalty.
Flicking through Securities Analysis, I am presented with an old style font and old-fashioned language but addressing issues that are perhaps as relevant today as they were back at the time of this edition: “One of the striking features of the past five years has been the domination of the financial scene by purely psychological elements…The new ‘new era’ doctrine – that ‘good’ stocks (or ‘blue chips’) were sound investments regardless of how high the price paid for them…”. Of course today those psychological elements have been studied and researched and condensed into styles or factors (value, size, momentum, etc) that can be bought and sold as specific indices.
What I also find curious is the authors’ linkage of the psychological factors to ‘intangible factors of value, viz., good-will, management, expected earning power, etc.’ In other words being wary of aspects of the business that are harder to put a valuation on, which goes to the heart of The Economist’s plea for an upgrade of valuation models.
The Economists’ plea is both enticing and worrying. As technological developments improve the efficiency of businesses across a broad range of sectors, there is some appeal to thinking differently about the intrinsic worth of companies – factoring in the rapid adoption of new ways of living and consumption. Certainly, recognising that research and development can lead to innovation and future growth. On the flipside, I clearly recollect in the late 1990s when a large part of the discussions on valuations concerned the ‘burn rate’ of cash rather than the long-term viability of the business. The bursting of the tech bubble quickly dismissed that focus.
Fortunately, The Economist’s leader concludes that ‘value investing’s rigour and scepticism are as relevant as ever’ so I don’t think we are being urged to turn our backs on the discipline mooted by messers Graham and Dodd or putting it more succinctly in the words of Michael Mauboussin[2] “to buy something for less than it is worth is as useful as ever.”
[1] The Economist, November 14th -20th, 2020 pp.15-16
[2] Researcher Morgan Stanley Investment Management, FT 18th November 2020, https://on.ft.com/3lFJALO
