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I am currently about halfway through a fascinating podcast in which William Green, author of Richer, Wiser, Happier, interviews Chris Begg, Chief Investment Officer of East Coast Asset Management. One of the most intriguing concepts in the podcast is the idea of Value Investing 3.0.

Value Investing 1.0 is Ben Graham. Graham counseled buying extremely cheap stocks based on statistical measures. Examples would be stocks trading below book value or for very low P/Es. This is what Graham practiced.

Warren Buffett, in the early part of his career, was a pure Graham disciple, following the ways of his mentor. He came to call these types of stocks “cigar butts.” They were frequently broken and declining businesses, but like a cigar butt they had one last puff in them that would allow the investor to sell for a profit.

But, under the tutelage of Charlie Munger, Buffett evolved, creating Value Investing 2.0. Perhaps the best way to summarize Value Investing 2.0 is this quote from Buffett: “It is better to buy a wonderful business at a fair price than a fair business at a wonderful price.” Munger taught Buffett to appreciate quality businesses who could compound earnings over long periods of time. These were where the really big gains lay.

Buffett’s investment in See’s Candy was his first education in this type of investing. Subsequent investments in Coke and more recently Apple are examples of this type of investing. These weren’t cheap stocks, but they became tremendous successes because they were quality businesses able to compound earnings – and their stock prices followed.

What, then, is Value Investing 3.0? a concept I had never heard until listening to Begg recently. Value Investing 3.0 goes beyond 2.0 in detecting hidden, intangible value in certain businesses. Perhaps it is best explored through some examples.

I remember when I was first learning about value investing more than 20 years ago through my ownership of The Longleaf Partners Fund mutual fund of Southeastern Asset management run by Mason Hawkins. Hawkins was kind of a hybrid of Value Investing 1.0 and 2.0.

At the time Bill Miller, who called himself a value investor, was buying Amazon, and there was a lot of controversy in the value investing community about how Amazon could be a value stock.

Hawkins didn’t think much of Miller’s value investing credentials after his purchase of Amazon. It was hard to see how it qualified as a value stock based on traditional measures like Price/Earnings, Price/Book, etc. Miller, however, took a very long view and saw something in Amazon and Bezos that wasn’t in the numbers. Ultimately, Amazon became one of the best performers of all time, vindicating Miller. A current example of such a stock that Begg talks about in the podcast is Tesla.

Value Investing 2.0 has spent a lot of time elaborating what quality consists of. The concept of moats has received a lot of attention for example. Value Investing 3.0 is even more esoteric; it’s almost as if it’s trying to look into the soul of a business.

“Character is destiny”, Heraclitus said. In retrospect, it’s no surprise Jeff Bezos built the juggernaut he set out to, the principles of which he laid out in Amazon’s first annual letter (1997). But at the time it was very hard to conceptualize how you might justify investing in the stock through a value investing prism.

With Tesla, you have to look past the current business of EVs and focus on self driving cars and robots, according to Begg. That is where the real possibility for big returns lies. But those products are still in the development phase. Their contribution to the business’s bottom line is a long way off.

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