Where the Money Is by Adam Seessel

Author:Adam Seessel
Language: eng
Format: epub
Publisher: Avid Reader Press / Simon & Schuster
Published: 2022-05-24T00:00:00+00:00

TOOLS TO KEEP BUT MODIFY

Like Buffett’s Value 2.0, Value 3.0 uses cash earnings as its valuation north star. What John Burr Williams wrote in The Theory of Investment Value more than eighty years ago remains true: the value of any business is the sum of all its future free cash flows, discounted back to the present at an appropriate interest rate. As a practical matter, however, it’s impossible and therefore fruitless to forecast such cash flows beyond a few years. The future is unpredictable and, outside a certain time horizon, completely unknowable. That’s why the price/earnings ratio based on current earnings has become such a popular shorthand: I’m paying $X for $Y in earnings that I can see today. Everything else is unclear.

What is clear, however, is that the P/E ratio based on current earnings has not captured the value that tech has created. If it had, Value 2.0 investors would have done exceedingly well with Amazon, Alphabet, and the rest over the last two decades. Instead, most value managers have underperformed the market rather badly, sniffing all the way at tech stocks as “expensive.” Because we’ve not adapted our methods, we’ve missed out on nearly a generation of wealth creation.

After my own period of underperformance in the mid-2010s, I broke the P/E tool down, trying to figure out why it wasn’t working and how I could modify it so that it would work again. In the end, I have altered the P/E construct in two material ways.

First, instead of looking only at this year’s or next year’s earnings, I look at earnings several years out. This exercise is not based on some wild-eyed dream of “the future.” I don’t propose to project out a decade, or even five years: nobody knows what’s going to happen that far out. On the other hand, certain digital companies have such strong competitive moats and are so early in their growth trajectory that it’s reasonable to forecast what their business will look like in a few years. What is the likelihood that Alphabet will grow its business over the next thirty-six months? What is the likelihood that Airbnb, DocuSign, Adobe, and dozens of other digital enterprises will continue to penetrate their markets? I think most reasonable people would agree that it’s probable such companies will grow over the next few years.

The second adjustment I make is more radical and more dramatic. It involves the concept of earnings power, which I introduced in chapter 4 when I compared Campbell’s to Intuit. While Campbell’s business is mature and therefore in harvest mode, Intuit’s is not. Faced with slow growth, Campbell’s is rightfully milking its business for every dollar of current earnings that it can. Intuit, on the other hand, is deploying billions into sales and marketing and research and development to grow future earnings. This spending is anchored in sound business logic, but it has the effect of depressing Intuit’s current reported profits.

Such aggressive spending behavior is common among tech companies. Facebook, Alphabet, Amazon, Apple,

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