EC Is The End Of The Value Trade Near?

“The best investments have a considerable margin of safety. This is Benjamin Graham’s concept of buying at a sufficient discount that even bad luck or the vicissitudes of the business cycle won’t derail an investment. – Seth Klarman

The problem with the current “value” trade is there is very little, if any, “margin of safety” in the companies investors are piling into. As discussed in “The Astonishing Lack Of Value:”

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

The chart is pretty stunning but needs some explanation.

Theoretically, book value represents the total amount a company is worth under a liquidation scenario. Such is the amount that the company’s creditors can expect to receive.

Book value analysis and buying companies with low “price-to-book” ratios have historically been profitable ventures. Companies with machinery, inventory, and equipment, and financial assets tend to have large book values. Significantly, these types of investments are easily valued and liquidated in the event of financial stress or bankruptcy.

However, today, as shown, such is no longer the case. With the rise in gaming, software, database, consultancies, etc., the increase in “intangible assets” has surged. Items such as patents, licenses, human capital, etc., now make up a significant portion of many company’s “value.”

These types of assets are hard to value and more difficult to liquidate. Such is especially the case with human capital or a measure of an employee’s skill set’s economic value.

 

The Evolution Of Intangibles

“Intangibles used to play a much smaller role than they do now, with physical assets comprising the majority of value for most enterprise companies. However, an increasingly competitive and digital economy has placed the focus on things like intellectual property, as companies race to out-innovate one another.

To measure this historical shift, Aon and the Ponemon Institute analyzed the value of intangible and tangible assets over nearly four and a half decades on the S&P 500. Here’s how they stack up:” – Visual Capitalist

(Click on image to enlarge)

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

“In just 43 years, intangibles have evolved from a supporting asset into a major consideration for investors – today, they make up 84% of all enterprise value on the S&P 500, a massive increase from just 17% in 1975.

Digital-centric sectors, such as internet & software and technology & IT, are heavily reliant on intangible assets. Brand Finance, which produces an annual ranking of companies based on intangible value, has companies in these sectors taking the top five spots on the 2019 edition of their report.” – Visual Capitalist

(Click on image to enlarge)

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

While the issues of “intangibles” should undoubtedly be a concern for “value” investors, another issue further compounding the problem. Debt and accounting gimmicks.

A Compounded Problem

As discussed previously in “EBITDA Is Bull****, the heavy use of accounting gimmicks is obfuscating publicly-traded companies’ actual value. As noted:

“An in-depth study by Audit Analytics revealed that 97% of companies in the S&P 500 used non-GAAP financials in 2017, up from 59% in 1996, while the average number of different non-GAAP metrics used per filing rose from 2.35 to 7.45 over two decades.

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

End Value Trade, #Technically Speaking: Is The End Of The Value Trade Near?

This growing divergence between the earnings calculated according to accepted accounting principles, and the ‘earnings’ touted in press releases and analyst research reports, has put investors at a disadvantage of understanding exactly what they are paying for.”

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