When Everything That Counts Can’t Be Counted

Courtesy of Joshua M Brown

An analysis of book value captures things like plants and equipment and facilities and hard-money, real assets that corporations have managed to accumulate over their lifetimes.

And when the cost of money is higher, these things are more highly valued by investors because they are expensive to replicate and costly to replace.

An analysis of book value doesn’t capture things like intellectual property and brand, intangible assets that corporations have accumulated or are currently accumulating.

And when the cost of money is lower (or, effectively zero) as it is today, these things become more highly valued by investors than physical assets are because they are weapons that corporations can use to nullify the moats and assets of the incumbent corporations that they are competing with for customers, revenue and market share.

This is why a AirBnB is currently more highly valued than all of the publicly traded hotel chains on the NYSE.

This is why Uber is worth more than all of the auto makers and taxi companies that own their own fleets of cars.

It’s why WeWork, which leases floors from building owners, is worth more than those building owners’ corporations.

This is how it’s possible that Beyond Meat, with its sizzling hot brand, could be worth exponentially more than the other publicly-traded food processing companies, with their century-old supply chains and manufacturing operations and union relationships and supermarket shelf space privileges and trucking contracts.

This is why the CEO of Goldman Sachs laments the fact that if his company’s Marcus online bank was a standalone “social finance” company backed by venture capitalists, it would be worth significantly more.

As he says this, note that the Goldman Sachs share price has just slipped below its tangible book value again. In the meantime, here’s PayPal’s price to book value – it has doubled over the last two years:

Nobody cares about PayPal’s book value because the truly valuable aspects of PayPal’s business – its brand, its ubiquity on the phones of millennials and its technological savvy – are not captured in the calculation of this metric. They lease office space, and they take market share. They don’t build factories or erect smokestacks off the side of the interstate highway.

And as a result of this popular preference for asset-light, recurring revenue model companies, factor (or smart beta) strategies that weight portfolios by the stocks’ price-to-book value have badly trailed the market.

Capital is Now Free, Have Fun

I had dinner with one of the foremost authors and thinkers in the history of the investment markets, William Bernstein, earlier this year. At the end of the dinner, Jason Zweig asked Bernstein “What’s the one thing that’s on your mind that no one else at this table is talking or thinking about right now?”

Bernstein said he’d been thinking about the question “What if the cost of capital never rises again?” The implications of a world in which equity capital is flowing while interest rates on credit never rise to the level of being a serious roadblock for innovation are fascinating to consider. What if every new idea that comes along, no matter how world-altering and disruptive, no matter how unproven or risky, can get overnight funding without much of a problem? Masayoshi Son’s Vision Fund has been investing based on this premise. Massive pools of capital from sovereign nations and university endowments and gigantic corporations like Google’s moonshot division are investing this way as well.

This question is being answered on Wall Street every day, even if the participants are not aware of it. Their actions and allocations have already decided what we think this world would look like. Value stocks have appreciated significantly less than growth stocks in the post-crisis period that’s been marked by a cost of capital that has approached zero. Value stocks have underperformed the overall stock market and their size within the indices has declined as a percentage of the weighting of these indices accordingly.

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Disclosure: Our teaching theme at Phil's Stock World is "Be the House, NOT the Gambler." Please see " more

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