WEBVTT - Michael Mauboussin On Valuing Intangible Assets 0:00:10.920 --> 0:00:14.920 Hello, and welcome to another episode of the Odd Lots Podcast. 0:00:14.960 --> 0:00:20.360 I'm Joe Eisenthal and I'm Tracy all Away. So, Tracy, obviously, 0:00:20.360 --> 0:00:25.599 we've had this extraordinary stock market comeback this year, not 0:00:25.680 --> 0:00:29.600 even really just a comeback, because, um, we've were so 0:00:29.640 --> 0:00:32.640 far ahead of where we started the year despite the pandemic, 0:00:33.240 --> 0:00:35.680 and a lot of different sectors have rallied. But there's 0:00:35.720 --> 0:00:41.040 no question that tech sort of new economy type stuff, 0:00:41.840 --> 0:00:44.479 however you define it, has really led the way. I mean, 0:00:44.520 --> 0:00:48.560 the nasdack is just having a sort of ridiculous year. Yeah, 0:00:48.720 --> 0:00:51.159 We've talked about this before, but to some extent, it 0:00:51.200 --> 0:00:55.240 feels like the coronavirus crisis that we've seen this year 0:00:55.280 --> 0:00:59.360 has accelerated long running trends in a bunch of things. 0:00:59.400 --> 0:01:03.080 So you for instance, the dominance of online retail, but 0:01:03.240 --> 0:01:07.320 also the out performance of the thing stocks UM and 0:01:07.360 --> 0:01:10.840 tech in general. It feels like the big just get bigger. 0:01:11.360 --> 0:01:14.360 Stocks that were considered expensive, you know, five years ago, 0:01:14.440 --> 0:01:17.560 are even more expensive now. Yeah, and I'm glad to 0:01:17.640 --> 0:01:20.800 use that word expensive because you know, it sort of 0:01:20.840 --> 0:01:26.959 does have a um an implied judgment expensive like people 0:01:27.000 --> 0:01:30.480 are overpaying and you know, people talk about value stocks, 0:01:30.520 --> 0:01:34.560 which has had this implied idea that you're getting a 0:01:34.640 --> 0:01:36.760 good value, you're getting a good deal, it's cheap. But 0:01:36.840 --> 0:01:40.440 we have had this phenomenon where stocks with high multiples 0:01:40.600 --> 0:01:44.039 continue to do extremely well, and the stocks that on 0:01:44.240 --> 0:01:47.680 paper appear to be cheap just seemed to get cheaper 0:01:47.680 --> 0:01:50.960 and cheaper, which is, you know, not great if you 0:01:51.000 --> 0:01:54.200 own them. Yeah, and of course this goes back to 0:01:54.280 --> 0:01:59.280 the whole value versus growth debate. Right, why has value 0:01:59.360 --> 0:02:03.920 been under performing as a strategy for so long? Uh? 0:02:03.960 --> 0:02:06.320 And there is an argument that a lot of this 0:02:06.480 --> 0:02:11.360 comes down to accounting and the notion that maybe we 0:02:11.440 --> 0:02:15.400 have outdated accounting rules that don't actually do a very 0:02:15.400 --> 0:02:18.080 good job of reflecting the world as it is today. 0:02:18.160 --> 0:02:20.840 And you know, we started out this conversation by talking 0:02:20.840 --> 0:02:25.440 about twenty You could certainly argue that accounting rules that were, 0:02:25.480 --> 0:02:29.400 you know, imposed back in the nineties seventies probably aren't 0:02:29.440 --> 0:02:33.080 doing a very good job of reflecting what's going on 0:02:33.160 --> 0:02:37.760 in in the midst of a global pandemic. Yeah, it 0:02:37.800 --> 0:02:40.960 seems like if you're a value investor, if you if 0:02:41.000 --> 0:02:44.360 you're self characterized value investor, there's corner. There's sort of 0:02:44.400 --> 0:02:48.880 two approaches that you can take. One is to sort 0:02:48.919 --> 0:02:51.000 of say, okay, we must be at some turning point. 0:02:51.080 --> 0:02:54.400 There's gonna be some catalyst, maybe some economic regime change, 0:02:54.760 --> 0:02:57.200 and then value stocks will do better. And then the 0:02:57.240 --> 0:03:01.440 other approaches just to redefine value and say value has 0:03:01.480 --> 0:03:04.760 done well if you define value this way and you 0:03:04.840 --> 0:03:07.760 sort of change your screens so that you could sort 0:03:07.760 --> 0:03:12.160 of fit more stocks into the value bucket. Yeah, there's 0:03:12.200 --> 0:03:14.560 a really um there's a kind of funny article from 0:03:14.560 --> 0:03:17.280 one of our Bloomberg colleagues out recently about a I 0:03:17.320 --> 0:03:21.120 think it was a South Korean plant firm or asset 0:03:21.200 --> 0:03:26.040 manager or something that created a new value driven e 0:03:26.280 --> 0:03:30.960 t F. But it, as you said, redefined what value 0:03:30.960 --> 0:03:35.280 actually was. And on that basis, I think it's base 0:03:35.360 --> 0:03:39.000 holdings ended up being Amazon, Alphabet and Facebook. So yeah, 0:03:39.080 --> 0:03:42.640 it's all about the definition, isn't it. Yeah, that's a 0:03:42.720 --> 0:03:45.280 very easy way for value investing to do well, just 0:03:45.320 --> 0:03:49.840 say we're allowed to buy Amazon and but but even 0:03:49.920 --> 0:03:52.760 still like it does raise the question and you know, 0:03:52.800 --> 0:03:56.040 one of the sort of classic screens, one of the 0:03:56.240 --> 0:03:59.200 classic tests for what counts as of value stock is 0:03:59.240 --> 0:04:01.120 to look at price to books, So how much you're 0:04:01.160 --> 0:04:04.040 paying for the company relative to its assets. But if 0:04:04.040 --> 0:04:07.640 you only have a conception of assets as being factories 0:04:07.680 --> 0:04:10.760 and land and other things like that, you are missing 0:04:11.680 --> 0:04:16.440 sort of, you know, other extremely valuable assets, such as, say, 0:04:16.560 --> 0:04:21.720 the network of connections that Facebook has built that is 0:04:21.760 --> 0:04:24.919 hard to replicate anywhere else. It's not an asset in 0:04:24.920 --> 0:04:28.080 the traditional sense like a piece of equipment is, but 0:04:28.160 --> 0:04:32.279 no one would actually dispute that it is an asset, right, 0:04:32.440 --> 0:04:35.200 And this is where the accounting rules come in, Right, 0:04:35.760 --> 0:04:40.680 why do we put certain things in certain places on 0:04:40.720 --> 0:04:43.760 an income statement versus somewhere else? Like why does a 0:04:43.800 --> 0:04:50.480 factory statement go here but research and development someplace else? Entirely, Yes, 0:04:51.080 --> 0:04:53.440 so we we we've we've talked about this a couple 0:04:53.480 --> 0:04:56.120 of times in the past, but it continues to sort 0:04:56.120 --> 0:04:59.000 of gain urgency again, I think in light of what 0:04:59.040 --> 0:05:01.520 we've seen in the market it um this year. So 0:05:01.800 --> 0:05:04.280 we're gonna talk about this topic somewhere. I'm really excited 0:05:04.279 --> 0:05:06.240 about our guests. We've had him on the show I 0:05:06.279 --> 0:05:10.320 think at least once before. Michael Mobrison. He is a 0:05:10.400 --> 0:05:16.120 managing director at Morgan Stanley, but a longtime career in finance, 0:05:16.160 --> 0:05:20.920 having worked in Blue Mountain Capital, leg Mason and so forth. 0:05:21.600 --> 0:05:25.760 His title, um at his current job is the head 0:05:25.839 --> 0:05:31.640 of Concilient Research on Counterpoint Global at Morgan Stanley Investment Management. 0:05:32.000 --> 0:05:35.520 So I'm going to uh introduce Michael, but first I'm 0:05:35.520 --> 0:05:39.000 going to ask him what is U concilient Research at 0:05:39.040 --> 0:05:42.720 Counterpoint Global. Man, Well, first of all, Joe and Tracy. 0:05:42.760 --> 0:05:44.920 Great to be with you guys again, always lots of fun. 0:05:45.360 --> 0:05:47.559 It is an unusual name. By the way, It's probably 0:05:47.560 --> 0:05:48.960 not a good idea to have a title that people 0:05:48.960 --> 0:05:50.760 have to look up in the dictionary, but that is 0:05:50.800 --> 0:05:53.479 the case here. Um. There's a there's a book I 0:05:53.520 --> 0:05:57.920 read in very influnch for me called Concilience by E. O. Wilson, 0:05:58.160 --> 0:06:01.880 famous biologist, and the argument very simply was that while 0:06:01.960 --> 0:06:04.520 science has made a major advances over over the last 0:06:04.560 --> 0:06:07.720 few centuries by reductionism, he argued that many of the 0:06:07.839 --> 0:06:10.360 vaccine important problems in our world were at the intersection 0:06:10.440 --> 0:06:13.680 of discipline. Concealing itself is the idea of the unification 0:06:13.720 --> 0:06:16.479 of knowledge and taking ideas from disparate areas and having 0:06:16.480 --> 0:06:19.200 them using them to solve problems. So when I was 0:06:19.240 --> 0:06:21.880 a credit SUI many years ago, I started newsletter called 0:06:21.880 --> 0:06:24.760 The Concilient Observer, and it was the idea was right, 0:06:24.800 --> 0:06:27.880 these short essays trying to bring ideas from various areas 0:06:27.920 --> 0:06:30.640 together to try to shed some light on a particular topic. 0:06:31.160 --> 0:06:33.640 Um So Dennis Lynch, who runs Counterpoint Global where I 0:06:33.680 --> 0:06:36.279 am was, was a reader of that, and so when 0:06:36.600 --> 0:06:39.680 when he invited me to join Counterpoint Global, which is 0:06:39.680 --> 0:06:41.359 part of More Fails in Best Management, he said, hey, 0:06:41.360 --> 0:06:44.279 why don't we call this concilient research? You know. So 0:06:44.279 --> 0:06:46.240 so that's where we look back that. But is this 0:06:46.320 --> 0:06:48.320 idea that we need to cast a wide net, by 0:06:48.360 --> 0:06:50.680 the way, which is a really good even introduction to 0:06:50.720 --> 0:06:52.839 the topic. As you guys were talking about as we 0:06:52.839 --> 0:06:55.600 think about the world, Uh, you know, are we thinking 0:06:55.600 --> 0:06:58.120 about things as expansively as we should to try to 0:06:58.200 --> 0:07:00.640 understand to make sense of the world. And um, so 0:07:00.720 --> 0:07:04.039 that that's where that comes from. Thank you for that explanation. 0:07:04.160 --> 0:07:06.920 Um it is a very interesting job title, I gotta say, 0:07:07.000 --> 0:07:10.640 but and it is quite wide ranging. Um I guess 0:07:11.000 --> 0:07:15.680 just to begin with why, well, you recently published a 0:07:15.720 --> 0:07:19.400 topic on intangible assets and Joe and I sort of 0:07:19.440 --> 0:07:22.200 set the scene for why this comes up nowadays in 0:07:22.240 --> 0:07:25.800 the debate between value versus growth, but maybe just to 0:07:25.840 --> 0:07:28.600 give us a little bit much more color, how much 0:07:28.680 --> 0:07:33.400 does this crop up in conversations with investors, how worrying 0:07:33.600 --> 0:07:39.120 or how much of a debate is this at the moment? Well, Tracy, 0:07:39.280 --> 0:07:40.760 I think it is a big one. And you know, 0:07:41.280 --> 0:07:43.760 to state the obvious, this idea that intangible to become 0:07:43.800 --> 0:07:46.040 more prominent is not new, and I think many people 0:07:46.040 --> 0:07:49.000 have pointed this out over time. The reason, you know, 0:07:49.080 --> 0:07:50.680 we try to rule up our sleeves a bit and 0:07:50.680 --> 0:07:53.920 and discuss this was sort of three big reasons. One 0:07:54.000 --> 0:07:56.000 is can we do a better job of measuring this? 0:07:56.840 --> 0:08:00.240 And the I think to me the centerpiece of that 0:08:00.400 --> 0:08:02.400 piece of research we can talk more about. It is 0:08:02.720 --> 0:08:05.240 an attempt to bring some of the measurement issues up 0:08:05.280 --> 0:08:07.840 to date and to get a really good sense of 0:08:07.920 --> 0:08:10.720 how big these intangible investments are relative to things we 0:08:10.800 --> 0:08:12.880 are more familiar with, like CAPAX and R and D 0:08:12.960 --> 0:08:16.480 and so forth. The second is, and I think Joe 0:08:16.520 --> 0:08:18.480 touched on I think you guys talked talked about this 0:08:18.480 --> 0:08:21.080 in your intro is what are the characteristics of knowledge 0:08:21.120 --> 0:08:26.120 goods versus intangible goods versus tangible goods? And just I 0:08:26.160 --> 0:08:29.560 want to underscore very strongly that there's nothing Economists of 0:08:29.600 --> 0:08:32.760 understood all these concepts for a very long time, but 0:08:33.280 --> 0:08:36.000 it's probably take on taking on more prominence and understanding 0:08:36.080 --> 0:08:38.840 of things like you know, scalability and so forth. And 0:08:38.880 --> 0:08:41.160 then the last thing is exactly what you guys are 0:08:41.160 --> 0:08:43.720 talking about, which is what is the implication? So you know, 0:08:43.760 --> 0:08:45.640 if I look at a company and it loses money, 0:08:46.440 --> 0:08:49.320 is that necessarily bad? Or how do I think about 0:08:49.360 --> 0:08:52.640 that with more subtlety? So you know, again, that's why 0:08:52.640 --> 0:08:55.120 I called the report. One job, which was your job 0:08:55.160 --> 0:08:58.520 as an investors and analysts hasn't changed. It's figuring out 0:08:58.520 --> 0:09:00.839 how much company is investing and what returns on the 0:09:00.880 --> 0:09:04.280 investment being what that means for future cash flows. But 0:09:04.400 --> 0:09:06.960 as you pointed out, Tracy, even in your observation about 0:09:06.960 --> 0:09:10.120 where things are getting recorded, your your job's got a 0:09:10.160 --> 0:09:12.319 little bit more challenging because you have to go you 0:09:12.360 --> 0:09:14.920 have to track down where the investments are, and they're 0:09:14.960 --> 0:09:17.840 not where they used to be. It talked to us 0:09:17.920 --> 0:09:20.000 about that a little bit further. There's a line in 0:09:20.160 --> 0:09:23.240 your in your report that caught my eye and I'll 0:09:23.240 --> 0:09:25.200 just read it says it used to be that earnings 0:09:25.200 --> 0:09:28.959 were on the income statement, and investments were recorded mostly 0:09:29.040 --> 0:09:32.680 on the balance sheet. The rise of intangible investments means 0:09:32.720 --> 0:09:35.040 that the bottom line is now a mix of earnings 0:09:35.160 --> 0:09:38.320 and investment sort of like break that down. That really 0:09:38.400 --> 0:09:42.640 jumped out at me. And this idea that looking that, uh, 0:09:42.720 --> 0:09:45.000 sort of things that were on one part of the 0:09:45.320 --> 0:09:48.880 income or financial statement moved to another. Why is this important? 0:09:48.920 --> 0:09:52.520 Why is this interesting? Yeah? And so you know, I 0:09:52.559 --> 0:09:55.560 think Joe. The answer is that historically, the kinds of 0:09:55.600 --> 0:09:58.839 things we thought of as investments, so think about factories 0:09:58.880 --> 0:10:02.280 and machines and inventory and so and so forth, those 0:10:02.320 --> 0:10:05.080 were classically recorded on the balance sheet, so they didn't 0:10:05.080 --> 0:10:08.360 show they showed up an income statement through things like depreciation, 0:10:08.440 --> 0:10:11.520 but they were essentially recorded on the balance sheet and 0:10:11.559 --> 0:10:15.959 had relatively modest influence on on the income statement. And 0:10:15.960 --> 0:10:18.640 and again those rules were laid out, by the way, 0:10:18.640 --> 0:10:22.679 incredibly valuable, right, Dual dual entry accounting very valuable, um, 0:10:22.800 --> 0:10:24.640 but in a in an ear that was very different 0:10:24.679 --> 0:10:27.920 than what we live in today. UM. So increasingly, the 0:10:28.000 --> 0:10:30.880 kinds of investments the company makes that are valuable, things 0:10:30.920 --> 0:10:34.280 like brand building or research and development or customer acquisition 0:10:34.320 --> 0:10:38.480 costs these are all just classically defined. They are also investments, right, 0:10:38.559 --> 0:10:41.640 These are things they're outlays today and the hope and 0:10:41.800 --> 0:10:45.040 expectation for future cash flows, but now those are being 0:10:45.040 --> 0:10:48.679 recorded on the income statement. And you know, I think 0:10:48.720 --> 0:10:51.679 Tracy mentioned at the in the opening about sort of 0:10:51.720 --> 0:10:54.160 these accounting rules. There's a very there's obviously a very 0:10:54.200 --> 0:10:58.320 interesting one from nineteen seventy four where the Financial Accounting 0:10:58.320 --> 0:11:01.480 Standards Boards was debate eating about how to treat research 0:11:01.520 --> 0:11:04.640 and development, right, which is sort of this classic in 0:11:04.720 --> 0:11:07.200 between thing, and you know, they actually looked at, you know, 0:11:07.200 --> 0:11:09.920 should we capitalize this, should there be rules for how 0:11:09.960 --> 0:11:12.400 to think about capitalizing it, or should we expense it? 0:11:12.440 --> 0:11:14.040 So court and then they ended up saying we're going 0:11:14.080 --> 0:11:16.319 to expend it, right, And the name it was in 0:11:16.360 --> 0:11:18.640 the name of being conservative, which is, we just don't 0:11:18.679 --> 0:11:20.720 know what the returns are gonna be, so we're just 0:11:20.720 --> 0:11:22.920 gonna plunk it all in here. And as you know, 0:11:23.000 --> 0:11:25.200 like you think about a young biotechnology company or even 0:11:25.280 --> 0:11:28.719 historically pig pharmaceutical companies, companies spending substantial percentage of the 0:11:28.800 --> 0:11:31.480 revenues on R and D to state the obvious, that's 0:11:31.480 --> 0:11:33.440 an investment right there. Doing that in a in a 0:11:33.520 --> 0:11:37.240 hope for future returns, but that's obviously wiping out sort of, 0:11:37.600 --> 0:11:40.680 it's hitting their earnings, um you know, a hundred cents 0:11:40.720 --> 0:11:43.400 on the dollar. So that that that's really the issue. 0:11:43.400 --> 0:11:46.160 And so over time we've we've seen this morphing from 0:11:46.200 --> 0:11:49.840 investments going from primarily balance sheet related to now income 0:11:49.880 --> 0:11:52.760 statement related. And so now we have all these ideas 0:11:52.760 --> 0:11:56.120 about capital life businesses and so forth. Well, in a 0:11:56.200 --> 0:11:57.839 sense they're capital life because there's not a lot of 0:11:57.840 --> 0:12:00.679 stuff recorded on the balance sheet. But it's not like 0:12:00.679 --> 0:12:03.599 they're not investing. They are investing, um. So, so that 0:12:03.760 --> 0:12:07.600 just where it shows up is different. Not the concepts 0:12:07.640 --> 0:12:10.360 behind investing doesn't change, but where it shows up. It 0:12:10.520 --> 0:12:14.319 is quite amazing that because of an accounting rule change, 0:12:14.400 --> 0:12:17.559 the way investors can think about a whole bunch of 0:12:17.640 --> 0:12:22.040 companies automatically changes because the investors are trying to gauge 0:12:22.559 --> 0:12:26.199 future profitability, I guess, and all of that comes down 0:12:26.280 --> 0:12:30.120 to the numbers that are presented on the earnings statement. 0:12:30.200 --> 0:12:33.000 Can you maybe elaborate a little bit on on how 0:12:33.120 --> 0:12:39.720 you see those accounting quirks changing or affecting investor behavior. 0:12:41.320 --> 0:12:43.240 So it's a great question tracing. And the first thing, 0:12:43.440 --> 0:12:45.360 and there's obviously a lot of chatter about this and 0:12:45.400 --> 0:12:47.640 the accounting community and so forth. The first thing I'll 0:12:47.640 --> 0:12:49.440 just say is just to keep our eye on the 0:12:49.480 --> 0:12:52.760 ball here, is that, notwithstanding all the adjustments you want 0:12:52.800 --> 0:12:55.160 to make, free cash flow, which is sort of the 0:12:55.200 --> 0:12:58.240 lifeblood of corporate valuation, which is really ultimately the cash 0:12:58.240 --> 0:13:00.679 in versus the cash out, free cash flows perturbed by 0:13:00.720 --> 0:13:03.640 these adjustments, so that doesn't really make any difference. And 0:13:03.640 --> 0:13:05.240 one of the reasons, you know, I opened the report 0:13:05.320 --> 0:13:08.600 with sort of this uh, you know, choice between two 0:13:08.600 --> 0:13:11.080 different investments. Of course it was the same company and 0:13:11.120 --> 0:13:13.719 one it was Walmart. But one showed you know, sort 0:13:13.760 --> 0:13:16.640 of the steady profitability and and and actually growing a 0:13:16.720 --> 0:13:18.600 very nice clip and so forth, and the other showing 0:13:18.760 --> 0:13:21.959 you know, rising dead and dwindling cash balances and so forth. 0:13:22.559 --> 0:13:25.120 And the key to Walmart was that it was this 0:13:25.160 --> 0:13:27.319 is from the early nineteen seventies through the mid nineteen 0:13:27.320 --> 0:13:31.120 eighties at Walmart was profitable but had negative free cash 0:13:31.120 --> 0:13:33.240 flow rights. And all that means is they were investing 0:13:33.280 --> 0:13:36.120 more than they earned. And since their investments were really 0:13:36.200 --> 0:13:38.040 high return, you know, you want them to do that 0:13:38.120 --> 0:13:41.680 you knock yourself out. That's fantastic. So now you say, 0:13:41.760 --> 0:13:44.439 a very similar company with also negative free cash flow, 0:13:44.720 --> 0:13:46.800 but investing on the income state would show losses on 0:13:46.840 --> 0:13:48.679 the right, they would show losses on the income statement, 0:13:48.679 --> 0:13:50.640 and we all sudden say that that doesn't look good. 0:13:51.200 --> 0:13:53.640 So um, so I think that there already there are 0:13:53.679 --> 0:13:56.360 sort of all this ongoing discussion about are there things 0:13:56.400 --> 0:13:58.679 we should do to change the nature of our accounting. 0:13:59.160 --> 0:14:02.080 The one, you know, the obvious one is research and development. Um. 0:14:02.160 --> 0:14:04.760 By the way, the other thing is interesting is this 0:14:04.840 --> 0:14:07.040 does happen in mergers and acquisitions. Right, So if you 0:14:07.200 --> 0:14:09.520 built a great company that has a wonderful brand and 0:14:09.559 --> 0:14:12.240 a great customer list and so forth, and my company 0:14:12.240 --> 0:14:14.800 acquires yours, all of a sudden those that there will 0:14:14.840 --> 0:14:17.160 be some good will, but the intangibles will reflected on 0:14:17.200 --> 0:14:19.120 my balance sheet and then I'm gonna admortise them over 0:14:19.160 --> 0:14:22.320 some period time, so they get acknowledged, but only in 0:14:22.400 --> 0:14:24.680 mergers and acquisitions, and they just don't get acknowledged and 0:14:24.760 --> 0:14:27.520 sort of day to day. So that's the ongoing discussion. 0:14:27.560 --> 0:14:29.840 Now I'm not going to wait around for accountants to 0:14:29.920 --> 0:14:32.480 change the rules. There it's a very conservative bunch, and 0:14:32.480 --> 0:14:35.600 I think I'm sympathetic to them being conservative. And my 0:14:35.680 --> 0:14:38.080 argument is the that that investors need to get on 0:14:38.120 --> 0:14:41.400 this without whether or without the accountants. The other thing 0:14:41.400 --> 0:14:43.720 that and you guys mentioned this in the opening as well, 0:14:44.040 --> 0:14:47.840 and I'm not going to sort of justified evaluations, but 0:14:48.080 --> 0:14:50.920 I think that the market understands these things, so this 0:14:51.040 --> 0:14:53.800 is not being lost on the market. So in a sense, 0:14:54.120 --> 0:14:56.960 as an investor, making thinking about this whole issue in 0:14:57.000 --> 0:14:59.920 a clearer fashion, I think get you more in step 0:15:00.000 --> 0:15:02.560 with how the markets already operating versus you know, putting 0:15:02.560 --> 0:15:05.280 you ahead of everybody else. Right, So, so the market 0:15:05.280 --> 0:15:07.840 I think has already sniffed this out in a major way. 0:15:07.920 --> 0:15:09.960 So you know, again there are things like you know, 0:15:10.080 --> 0:15:13.840 customer lifetime value calculations and research and development and branding. 0:15:14.440 --> 0:15:17.560 There's there have been for long decades discussions about how 0:15:17.560 --> 0:15:20.080 to treat those from an accounting point of view. And 0:15:20.120 --> 0:15:22.920 again this weird thing about if you're your own company 0:15:23.000 --> 0:15:25.080 versus if you get acquired to get treated differently and 0:15:25.080 --> 0:15:27.840 so forth. So um, yeah, it's an ongoing discussion, but 0:15:27.880 --> 0:15:29.640 I'm saying, like, don't wait around for the accounts to 0:15:29.640 --> 0:15:32.880 make your try to quotes, make your life easier, figure 0:15:32.920 --> 0:15:34.880 it out yourself, right, And that's why I called it 0:15:34.920 --> 0:15:36.640 one job. I'm like, look, this is what you have 0:15:36.680 --> 0:15:38.760 to do. This is that these are the cards that 0:15:38.800 --> 0:15:41.000 have been dealt and play them. So it's like, if 0:15:41.000 --> 0:15:44.640 we look at some software company and it's trading at 0:15:44.720 --> 0:15:47.560 thirty x revenue're like and they're like, that's crazy, it's 0:15:47.560 --> 0:15:51.360 a bubble. And the idea of basically what you're saying 0:15:51.560 --> 0:15:55.520 is not that this approach will necessarily tell you whether 0:15:55.640 --> 0:15:58.040 the stock is a buyer or sell or over valued 0:15:58.160 --> 0:16:02.000 or not, but that at least we can appreciate how 0:16:02.080 --> 0:16:04.920 the market is valuing the company and then from there 0:16:05.320 --> 0:16:08.720 make further do further analysis to say whether it's a 0:16:08.720 --> 0:16:12.240 buyers though. That's right, Joe, and you know that. Um. 0:16:12.240 --> 0:16:14.960 About twenty years ago I published a book called Expectations 0:16:14.960 --> 0:16:18.000 Investing My call through our wrap Board, and the argument 0:16:18.040 --> 0:16:20.160 we made there was, you know what you should do 0:16:20.200 --> 0:16:22.560 is start start with a stock price and the market value, 0:16:22.640 --> 0:16:25.120 and then reverse engineer what has to happen for that 0:16:25.200 --> 0:16:27.640 to make sense. Right, So you might ask the question, 0:16:27.680 --> 0:16:29.880 you know, if it's a software company with sales, be 0:16:29.960 --> 0:16:32.560 in retention so on and so forth, and I still 0:16:32.560 --> 0:16:34.960 think that's a very sensible way. So again, I'm not 0:16:35.000 --> 0:16:38.480 here to defend any valuations for any company, but by 0:16:38.520 --> 0:16:40.760 the same token, and this you're you're exactly right. You 0:16:40.920 --> 0:16:43.720 you in other words, a very high percentage of companies 0:16:45.160 --> 0:16:48.200 of companies listen, companies United States lose money. And if 0:16:48.200 --> 0:16:50.840 you just said to yourself, ge, losing money is bad, 0:16:51.280 --> 0:16:54.600 you maybe throw all those things out and you're not acknowledging, 0:16:55.040 --> 0:16:56.960 And that would be like saying free cash flow negative, 0:16:56.960 --> 0:16:58.920 free cash flow is bad. No, that's not true. It's 0:16:58.920 --> 0:17:00.960 a much more subtle issue. You have to understand that 0:17:01.400 --> 0:17:04.320 the magnitude and return on investments, and only with that 0:17:04.359 --> 0:17:06.360 additional insight will you be able to make a sort 0:17:06.359 --> 0:17:20.800 of measure judgment. I know you just you literally just 0:17:20.840 --> 0:17:23.440 said that you're not here to um to make judgments 0:17:23.480 --> 0:17:27.800 on any particular companies valuation, But could you could you 0:17:27.840 --> 0:17:30.280 maybe give us your opinion on on one of the 0:17:30.359 --> 0:17:33.400 thing stocks or what would the thing stocks look like 0:17:33.960 --> 0:17:38.400 through the framework that you've just um explained to us, 0:17:38.440 --> 0:17:41.800 Like how different does something like an Amazon or an 0:17:41.800 --> 0:17:45.280 alphabet look once you start to factor in things like 0:17:45.320 --> 0:17:49.800 intangibles and research and development. Um So, Tracy, I think 0:17:49.800 --> 0:17:52.200 that the one I feel most comfortable with its Microsoft, 0:17:52.200 --> 0:17:54.720 So that's in the same neighborhood probably, And that's the 0:17:54.760 --> 0:17:57.639 example we used in the report. I'll just underscore again 0:17:57.640 --> 0:17:59.520 this is not an investment. There's no one investment of 0:17:59.600 --> 0:18:02.040 lolagent going on what to suggest. But what we did 0:18:02.080 --> 0:18:05.000 is we went through and made these adjustments. And again 0:18:05.080 --> 0:18:08.200 there's a lot of um A judgment as to how 0:18:08.200 --> 0:18:10.320 to make these adjustments in terms of what items should 0:18:10.320 --> 0:18:14.240 be intangible versus version of regular expense, and what is 0:18:14.280 --> 0:18:17.280 the amortization period and so forth. But we there was 0:18:17.600 --> 0:18:19.639 there's a professor named Charles Holton who had done a 0:18:19.640 --> 0:18:21.840 paper on Microsoft who laid out of frameworks, and we 0:18:21.880 --> 0:18:24.320 just said we're gonna follow the Holton framework. Um So, 0:18:24.400 --> 0:18:27.240 to answer your question more directly, what happened was the 0:18:27.240 --> 0:18:30.600 the UH. The technical term is net opcording profit after 0:18:30.600 --> 0:18:32.520 two tax But basically, think the cash rings of the 0:18:32.560 --> 0:18:35.720 company after these adjustments went up by about fifteen percent 0:18:36.720 --> 0:18:39.240 and the invested capital, so the amount of money invested 0:18:39.240 --> 0:18:42.520 in the business went up by about eight percent. Right. 0:18:42.600 --> 0:18:45.440 So again, when you're make when you reverse these UH 0:18:45.720 --> 0:18:48.160 expenses and put them on the bouncy Two things happen 0:18:48.680 --> 0:18:50.840 to take The obvious one is at earnings go up, 0:18:51.480 --> 0:18:54.359 and second is the amount of capital invested goes up. 0:18:54.800 --> 0:18:57.360 So for my Microsoft, and again MICROSOFT'SFT is a very big, 0:18:57.480 --> 0:19:00.440 very profitable, very successful company, and that was a fifteen 0:19:00.480 --> 0:19:03.879 percent lift to their earnings and about it again, increase 0:19:03.920 --> 0:19:07.720 in their capital. You might imagine quite easily that for 0:19:07.840 --> 0:19:11.360 much smaller company and younger companies and earlier in their 0:19:11.560 --> 0:19:14.840 in their development though, the impact would be even more profound. 0:19:15.160 --> 0:19:17.400 So that gives you some sense. So automatically you start 0:19:17.440 --> 0:19:21.320 to say, well people use historical pe multiples or so forth, 0:19:21.400 --> 0:19:24.360 you know you're just getting you're comparing apples to oranges 0:19:24.600 --> 0:19:26.920 if you start to do those kinds of things or 0:19:26.960 --> 0:19:31.359 take them too seriously. So, just on the example of Microsoft, 0:19:31.400 --> 0:19:34.120 and going back to research and development, you mentioned that, 0:19:34.359 --> 0:19:38.280 you know, Fast by the US Accounting UM Standards Center 0:19:38.600 --> 0:19:42.640 back in the ninet seventies made this decision to expense 0:19:42.960 --> 0:19:46.080 R and D because they wanted to be conservative. When 0:19:46.160 --> 0:19:50.320 you look at research and development today, is it all 0:19:50.359 --> 0:19:54.080 about generating future profits or when it comes to a 0:19:54.080 --> 0:19:58.000 company like Microsoft in a very competitive industry, is some 0:19:58.119 --> 0:20:03.120 of it just about I guess like keeping up and 0:20:03.560 --> 0:20:07.840 maintenance rather than betting on the future. Yeah, suddenly make 0:20:07.840 --> 0:20:09.520 two points. First of all, we talked about this directly 0:20:09.520 --> 0:20:11.960 in the report Tracy. It's a very good question. Um. 0:20:12.000 --> 0:20:13.680 One way to think about if you just want to say, 0:20:13.720 --> 0:20:15.439 I want a rough way to sort this in my 0:20:15.480 --> 0:20:17.919 own mind is exactly what you said, which is like, 0:20:17.960 --> 0:20:20.040 how do I think about what's an investment versus what 0:20:20.200 --> 0:20:23.760 is necessary to run? It's precisely that, so say to yourself, 0:20:23.760 --> 0:20:25.120 and you might you know, this would be a great 0:20:25.200 --> 0:20:28.240 question for executives, right, you say, all right, what's spending 0:20:28.400 --> 0:20:32.359 on our income statement and specifically selling general administrative costs? 0:20:32.640 --> 0:20:35.320 What spending do we need just to keep this thing going? Right, 0:20:35.359 --> 0:20:39.280 We'll call that maintenance. And then what spending is truly discretionary, 0:20:39.280 --> 0:20:41.439 that is in pursuit of growth, and that we'll call 0:20:41.480 --> 0:20:44.280 it value creating growth. Right, So that segregation is really 0:20:44.359 --> 0:20:47.240 just a simple way to think about this. And um, 0:20:47.280 --> 0:20:49.600 as I mentioned in the Holton and usually people talk 0:20:49.640 --> 0:20:51.560 about this for R and D, they often will make 0:20:51.560 --> 0:20:55.760 it intangible and you know, for like a young pharmaceutical 0:20:55.800 --> 0:20:59.199 company or biotakers, and that's probably that's probably reasonable, but 0:20:59.359 --> 0:21:01.440 very much to your point with the argument, and we 0:21:01.600 --> 0:21:04.480 draw this out in the report. But for large, older, 0:21:04.840 --> 0:21:08.879 more established digital companies, it makes sense that a chunk 0:21:09.000 --> 0:21:10.960 and maybe even a meaningful chunk of R and D 0:21:11.160 --> 0:21:13.720 is just in quotes maintenance, right. So you know, when 0:21:13.760 --> 0:21:18.000 you get your automatic Windows updates on your computer, a 0:21:18.000 --> 0:21:20.240