Valuentum Exclusive Analysis for the Discerning Investor

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We're finally getting a pause in the rapid ascent of the markets on September 3rd. Though headlines may look scary and momentum/volatility investors could start to pile on to the downside, a modest retracement is actually a good thing. We continue to focus on the long haul with our processes, and we're viewing the sell-off as profit taking, for the most part.

In the near term, the markets will also have to digest some speculators betting on mean reversion between "value" (cyclical) versus "growth" (secular), but we maintain the view that the value-versus-growth conversation is largely nonsense (see block quotes below), and mean reversion is something akin to the gamblers' fallacy, in my humble opinion. Investors should also continue to expect outsize volatility, something every member should be anticipating given the prevalence of price-agnostic trading. Nothing in today's trading session should be surprising. 

Through the course of the COVID-19 crisis, I have learned to appreciate enterprise valuation even more. In the first edition of Value Trap (December 2018), I explained how investors should prepare for "one of the most volatile periods in stock market history," pointing to enterprise valuation and the Best Ideas Newsletter and Dividend Growth Newsletter portfolios, in particular, as ways to guard against the declines. Many Valuentum stocks, or ones that had key cash-based drivers of intrinsic value such as net cash and future expected free cash flows, as well as moaty attributes (sustainable competitive advantages), attractive economic castles (large foreseeable economic profit spreads), and asset-light (capex light) recurring business models not only persevered during the pandemic, but many of these companies turned out to be "pandemic-resistant," if not "pandemic proof."

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Though the concentration of undervalued equities, as derived by the enterprise valuation process, has been within the large cap growth bucket in the years following the Great Financial Crisis and during the COVID-19 crisis, bargains based on enterprise valuation (and the Valuentum process) will inevitably move around the traditional style box. However, with most measures of quant value failing to capture the very essence of intrinsic value estimation, the future hopes of systematic quant value, which weighs accounting book value heavily, are riding only on the gambler's fallacy, in my view. Accounting book value, which coincidentally Warren Buffett abandoned in his 2018 Letter to Berkshire Hathaway Shareholders (45), is about as arbitrary of an accounting measure as it gets (read more about this in Value Trap), and other single-year snapshot valuation multiples continue to suffer from the many shortcomings outlined in this text...

...Whether it's B/M, P/E, EV/EBITDA, or another single-year snapshot valuation multiple, they all suffer from similar pitfalls, including but not limited to the application of realized (not expected) data and the absence of capturing the long-duration components of equity value in a fundamental anchor. If today's factor-based quant practitioners use the components of enterprise valuation, as in adjusting book value for intangibles (measured on the basis of future free cash flows in enterprise valuation) and point to interest rates (the discounting mechanism for future free cash flows in enterprise valuation) to explain varying performance of "growth" and "value" stocks, it only builds the case for enterprise valuation as the primary causal driver behind stock prices and returns, as Value Trap argues. Value investing is not dying or dead. Quant investors have been measuring value all wrong. In many ways, value investing has been thriving for those employing the enterprise valuation process.

What I want you to understand is that traditional single-year snapshot valuation multiples are largely arbitrary. For example, a company with a large net cash position could trade at a high multiple of earnings just because of that net cash position (net cash elevates the earnings multiple, irrespective of growth or earnings). The opposite is also true. A company with a large net debt position could trade at a low multiple of earnings just because of that net debt position (net debt reduces the earnings multiple, irrespective of growth or earnings). The level of the multiple, itself, is not as informative as one may want it to be. There are many other examples that skew multiples, including off-balance sheet liabilities, hidden assets such as stakes in other companies, and many, many others. Single-year snapshot multiples could at times be very misleading, and stocks are often mis-categorized into arbitrary buckets as a result.

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