Superb companies
Leaders in the value investment industry
Today’s post will take a look at how Mr. Market is grappling with intangibles. Let me start by suggesting why investors, generally, would want to know this.
We are all Mr. Market
Whether we like it or not, we are all Mr. Market. Mr. Market isn’t just emotional retail investors. It includes professional money managers, chartered financial analysts, financial advisors and most others in the finance industry.
Believing, as I do, that prices and values frequently get out of whack with each other, I find it useful to reflect on what other investors might think causes this. I want to know what the conventional wisdom is amongst all players making up Mr. Market, including highly sophisticate professional money managers.
Where all the players are at in terms of grappling with company investment in intangibles is important for anyone investing in the stock market. Where the FASB (Financial Accounting Standards Board and the IASB (International Accounting Standards Board) with input from the CFA Institute Research and Policy Centre (Certified Financial Analysts) are at, was discussed in my recent post here.
As I noted in that post, the shift of company capital investment to intangibles means company income statements and balance sheets have become largely irrelevant for investors.
We saw in that post that the investment analyst community has little appetite for change in accounting practices. The problem will only get worse.
How are professional money managers coping?
We can look at this through the eyes of a very experienced and successful money manager. Bill Nygren is a partner and the chief investment officer-U.S. at Harris Associates/Oakmark Funds, a firm with about $25 billion under management. He is also the co-portfolio manager of two Oakmark Funds. He is a self-described value investor.
He was interviewed recently on FinChat, see here. I was alerted to the interview by The Acquirer’s Multiple.
The interview is worth watching in its entirety. For present purposes, Nygren gives the purchase of Apple in 2009 as the largest single mistake he has made over the years. See interview minute 55.00 and ff. As he explains, it was a mistake that taught him a very valuable lesson. The mistake, he says, was to put Apple into their portfolio at a small position size. They did this because he was concerned how his clients would view Apple in a portfolio with traditional blue-chip companies with low P/Es and P/Bs. He says they were way more cautious than they should have been on Apple. This lesson taught them to buy other companies in the modern intangibles economy. He says he learned a lot from the under-position sizing of Apple lesson.
Emerging conventional wisdom
Nygren’s comments shed light on where big money managers are in terms of intangibles. At 57:44 Nygren says: “I think we have become leaders in the value investment industry for buying companies where intangibles have become their largest asset and you can’t see from a price to earnings or price to book how cheap the company is. I’m not sure we’d have gotten as far as fast as we did on that had we not made the under-investment in Apple we did.” (Emphasis Added)
One other quote from this interview is worth noting. At 15:08 Nygren says: “I think what’s changed is that trying to estimate what a business is worth has become more complicated. Forty years ago, return of businesses were much more tied to physical assets. So, it was easier to say, ‘if a company’s got a $30 book value they’ll probably earn somewhere about 15% on that, some number of years out, $4 to $5 per share earnings is a pretty reasonable projection.’ The world we live in today, the returns are much more tied to intangibles. So, it’s harder to just look at a book value number and say, 5 years from now they should earn X% on equity.”
He goes on to explain that more of a subjective business assessment is needed, through an understanding of how a business works and analysing its competitive situation.
This hearkens back to Warren Buffett’s explanation that his attitude when buying common stock is to “approach the transaction as if we were buying into a private business…When investing, we view ourselves as business analysts – not as market analysts, not as macroeconomic analysts, and not even as security analysts.” (Buffett, The Essays of Warren Buffett: Lessons for Corporate America. 1998) p63
Conclusion
As I suggested in my recent post, I doubt that we are on our way back to a less complicated world. In such a world, investors could use earnings and book value to make pretty reasonable projections. I don’t see that happening. Since 2009 some investors, like Bill Nygren, have learned about investing in a world of intangibles. Many have not.
I see constant references in the business news about the priciness of stocks in relation to P/E and P/B ratios.
This suggests to me that Mr. Market has still not really come to terms with intangibles. From time to time, Mr. Market will still offer up shares in wonderful intangible rich companies at bargain prices.
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