Speaker 1: Hello, and welcome to another episode of the Odd Lots Podcast.
Speaker 1: I'm Joe Eisenthal and I'm Tracy all Away. So, Tracy, obviously,
Speaker 1: we've had this extraordinary stock market comeback this year, not
Speaker 1: even really just a comeback, because, um, we've were so
Speaker 1: far ahead of where we started the year despite the pandemic,
Speaker 1: and a lot of different sectors have rallied. But there's
Speaker 1: no question that tech sort of new economy type stuff,
Speaker 1: however you define it, has really led the way. I mean,
Speaker 1: the nasdack is just having a sort of ridiculous year. Yeah,
Speaker 1: We've talked about this before, but to some extent, it
Speaker 1: feels like the coronavirus crisis that we've seen this year
Speaker 1: has accelerated long running trends in a bunch of things.
Speaker 1: So you for instance, the dominance of online retail, but
Speaker 1: also the out performance of the thing stocks UM and
Speaker 1: tech in general. It feels like the big just get bigger.
Speaker 1: Stocks that were considered expensive, you know, five years ago,
Speaker 1: are even more expensive now. Yeah, and I'm glad to
Speaker 1: use that word expensive because you know, it sort of
Speaker 1: does have a um an implied judgment expensive like people
Speaker 1: are overpaying and you know, people talk about value stocks,
Speaker 1: which has had this implied idea that you're getting a
Speaker 1: good value, you're getting a good deal, it's cheap. But
Speaker 1: we have had this phenomenon where stocks with high multiples
Speaker 1: continue to do extremely well, and the stocks that on
Speaker 1: paper appear to be cheap just seemed to get cheaper
Speaker 1: and cheaper, which is, you know, not great if you
Speaker 1: own them. Yeah, and of course this goes back to
Speaker 1: the whole value versus growth debate. Right, why has value
Speaker 1: been under performing as a strategy for so long? Uh?
Speaker 1: And there is an argument that a lot of this
Speaker 1: comes down to accounting and the notion that maybe we
Speaker 1: have outdated accounting rules that don't actually do a very
Speaker 1: good job of reflecting the world as it is today.
Speaker 1: And you know, we started out this conversation by talking
Speaker 1: about twenty You could certainly argue that accounting rules that were,
Speaker 1: you know, imposed back in the nineties seventies probably aren't
Speaker 1: doing a very good job of reflecting what's going on
Speaker 1: in in the midst of a global pandemic. Yeah, it
Speaker 1: seems like if you're a value investor, if you if
Speaker 1: you're self characterized value investor, there's corner. There's sort of
Speaker 1: two approaches that you can take. One is to sort
Speaker 1: of say, okay, we must be at some turning point.
Speaker 1: There's gonna be some catalyst, maybe some economic regime change,
Speaker 1: and then value stocks will do better. And then the
Speaker 1: other approaches just to redefine value and say value has
Speaker 1: done well if you define value this way and you
Speaker 1: sort of change your screens so that you could sort
Speaker 1: of fit more stocks into the value bucket. Yeah, there's
Speaker 1: a really um there's a kind of funny article from
Speaker 1: one of our Bloomberg colleagues out recently about a I
Speaker 1: think it was a South Korean plant firm or asset
Speaker 1: manager or something that created a new value driven e
Speaker 1: t F. But it, as you said, redefined what value
Speaker 1: actually was. And on that basis, I think it's base
Speaker 1: holdings ended up being Amazon, Alphabet and Facebook. So yeah,
Speaker 1: it's all about the definition, isn't it. Yeah, that's a
Speaker 1: very easy way for value investing to do well, just
Speaker 1: say we're allowed to buy Amazon and but but even
Speaker 1: still like it does raise the question and you know,
Speaker 1: one of the sort of classic screens, one of the
Speaker 1: classic tests for what counts as of value stock is
Speaker 1: to look at price to books, So how much you're
Speaker 1: paying for the company relative to its assets. But if
Speaker 1: you only have a conception of assets as being factories
Speaker 1: and land and other things like that, you are missing
Speaker 1: sort of, you know, other extremely valuable assets, such as, say,
Speaker 1: the network of connections that Facebook has built that is
Speaker 1: hard to replicate anywhere else. It's not an asset in
Speaker 1: the traditional sense like a piece of equipment is, but
Speaker 1: no one would actually dispute that it is an asset, right,
Speaker 1: And this is where the accounting rules come in, Right,
Speaker 1: why do we put certain things in certain places on
Speaker 1: an income statement versus somewhere else? Like why does a
Speaker 1: factory statement go here but research and development someplace else? Entirely, Yes,
Speaker 1: so we we we've we've talked about this a couple
Speaker 1: of times in the past, but it continues to sort
Speaker 1: of gain urgency again, I think in light of what
Speaker 1: we've seen in the market it um this year. So
Speaker 1: we're gonna talk about this topic somewhere. I'm really excited
Speaker 1: about our guests. We've had him on the show I
Speaker 1: think at least once before. Michael Mobrison. He is a
Speaker 1: managing director at Morgan Stanley, but a longtime career in finance,
Speaker 1: having worked in Blue Mountain Capital, leg Mason and so forth.
Speaker 1: His title, um at his current job is the head
Speaker 1: of Concilient Research on Counterpoint Global at Morgan Stanley Investment Management.
Speaker 1: So I'm going to uh introduce Michael, but first I'm
Speaker 1: going to ask him what is U concilient Research at
Speaker 1: Counterpoint Global. Man, Well, first of all, Joe and Tracy.
Speaker 1: Great to be with you guys again, always lots of fun.
Speaker 1: It is an unusual name. By the way, It's probably
Speaker 1: not a good idea to have a title that people
Speaker 1: have to look up in the dictionary, but that is
Speaker 1: the case here. Um. There's a there's a book I
Speaker 1: read in very influnch for me called Concilience by E. O. Wilson,
Speaker 1: famous biologist, and the argument very simply was that while
Speaker 1: science has made a major advances over over the last
Speaker 1: few centuries by reductionism, he argued that many of the
Speaker 1: vaccine important problems in our world were at the intersection
Speaker 1: of discipline. Concealing itself is the idea of the unification
Speaker 1: of knowledge and taking ideas from disparate areas and having
Speaker 1: them using them to solve problems. So when I was
Speaker 1: a credit SUI many years ago, I started newsletter called
Speaker 1: The Concilient Observer, and it was the idea was right,
Speaker 1: these short essays trying to bring ideas from various areas
Speaker 1: together to try to shed some light on a particular topic.
Speaker 1: Um So Dennis Lynch, who runs Counterpoint Global where I
Speaker 1: am was, was a reader of that, and so when
Speaker 1: when he invited me to join Counterpoint Global, which is
Speaker 1: part of More Fails in Best Management, he said, hey,
Speaker 1: why don't we call this concilient research? You know. So
Speaker 1: so that's where we look back that. But is this
Speaker 1: idea that we need to cast a wide net, by
Speaker 1: the way, which is a really good even introduction to
Speaker 1: the topic. As you guys were talking about as we
Speaker 1: think about the world, Uh, you know, are we thinking
Speaker 1: about things as expansively as we should to try to
Speaker 1: understand to make sense of the world. And um, so
Speaker 1: that that's where that comes from. Thank you for that explanation.
Speaker 1: Um it is a very interesting job title, I gotta say,
Speaker 1: but and it is quite wide ranging. Um I guess
Speaker 1: just to begin with why, well, you recently published a
Speaker 1: topic on intangible assets and Joe and I sort of
Speaker 1: set the scene for why this comes up nowadays in
Speaker 1: the debate between value versus growth, but maybe just to
Speaker 1: give us a little bit much more color, how much
Speaker 1: does this crop up in conversations with investors, how worrying
Speaker 1: or how much of a debate is this at the moment? Well, Tracy,
Speaker 1: I think it is a big one. And you know,
Speaker 1: to state the obvious, this idea that intangible to become
Speaker 1: more prominent is not new, and I think many people
Speaker 1: have pointed this out over time. The reason, you know,
Speaker 1: we try to rule up our sleeves a bit and
Speaker 1: and discuss this was sort of three big reasons. One
Speaker 1: is can we do a better job of measuring this?
Speaker 1: And the I think to me the centerpiece of that
Speaker 1: piece of research we can talk more about. It is
Speaker 1: an attempt to bring some of the measurement issues up
Speaker 1: to date and to get a really good sense of
Speaker 1: how big these intangible investments are relative to things we
Speaker 1: are more familiar with, like CAPAX and R and D
Speaker 1: and so forth. The second is, and I think Joe
Speaker 1: touched on I think you guys talked talked about this
Speaker 1: in your intro is what are the characteristics of knowledge
Speaker 1: goods versus intangible goods versus tangible goods? And just I
Speaker 1: want to underscore very strongly that there's nothing Economists of
Speaker 1: understood all these concepts for a very long time, but
Speaker 1: it's probably take on taking on more prominence and understanding
Speaker 1: of things like you know, scalability and so forth. And
Speaker 1: then the last thing is exactly what you guys are
Speaker 1: talking about, which is what is the implication? So you know,
Speaker 1: if I look at a company and it loses money,
Speaker 1: is that necessarily bad? Or how do I think about
Speaker 1: that with more subtlety? So you know, again, that's why
Speaker 1: I called the report. One job, which was your job
Speaker 1: as an investors and analysts hasn't changed. It's figuring out
Speaker 1: how much company is investing and what returns on the
Speaker 1: investment being what that means for future cash flows. But
Speaker 1: as you pointed out, Tracy, even in your observation about
Speaker 1: where things are getting recorded, your your job's got a
Speaker 1: little bit more challenging because you have to go you
Speaker 1: have to track down where the investments are, and they're
Speaker 1: not where they used to be. It talked to us
Speaker 1: about that a little bit further. There's a line in
Speaker 1: your in your report that caught my eye and I'll
Speaker 1: just read it says it used to be that earnings
Speaker 1: were on the income statement, and investments were recorded mostly
Speaker 1: on the balance sheet. The rise of intangible investments means
Speaker 1: that the bottom line is now a mix of earnings
Speaker 1: and investment sort of like break that down. That really
Speaker 1: jumped out at me. And this idea that looking that, uh,
Speaker 1: sort of things that were on one part of the
Speaker 1: income or financial statement moved to another. Why is this important?
Speaker 1: Why is this interesting? Yeah? And so you know, I
Speaker 1: think Joe. The answer is that historically, the kinds of
Speaker 1: things we thought of as investments, so think about factories
Speaker 1: and machines and inventory and so and so forth, those
Speaker 1: were classically recorded on the balance sheet, so they didn't
Speaker 1: show they showed up an income statement through things like depreciation,
Speaker 1: but they were essentially recorded on the balance sheet and
Speaker 1: had relatively modest influence on on the income statement. And
Speaker 1: and again those rules were laid out, by the way,
Speaker 1: incredibly valuable, right, Dual dual entry accounting very valuable, um,
Speaker 1: but in a in an ear that was very different
Speaker 1: than what we live in today. UM. So increasingly, the
Speaker 1: kinds of investments the company makes that are valuable, things
Speaker 1: like brand building or research and development or customer acquisition
Speaker 1: costs these are all just classically defined. They are also investments, right,
Speaker 1: These are things they're outlays today and the hope and
Speaker 1: expectation for future cash flows, but now those are being
Speaker 1: recorded on the income statement. And you know, I think
Speaker 1: Tracy mentioned at the in the opening about sort of
Speaker 1: these accounting rules. There's a very there's obviously a very
Speaker 1: interesting one from nineteen seventy four where the Financial Accounting
Speaker 1: Standards Boards was debate eating about how to treat research
Speaker 1: and development, right, which is sort of this classic in
Speaker 1: between thing, and you know, they actually looked at, you know,
Speaker 1: should we capitalize this, should there be rules for how
Speaker 1: to think about capitalizing it, or should we expense it?
Speaker 1: So court and then they ended up saying we're going
Speaker 1: to expend it, right, And the name it was in
Speaker 1: the name of being conservative, which is, we just don't
Speaker 1: know what the returns are gonna be, so we're just
Speaker 1: gonna plunk it all in here. And as you know,
Speaker 1: like you think about a young biotechnology company or even
Speaker 1: historically pig pharmaceutical companies, companies spending substantial percentage of the
Speaker 1: revenues on R and D to state the obvious, that's
Speaker 1: an investment right there. Doing that in a in a
Speaker 1: hope for future returns, but that's obviously wiping out sort of,
Speaker 1: it's hitting their earnings, um you know, a hundred cents
Speaker 1: on the dollar. So that that that's really the issue.
Speaker 1: And so over time we've we've seen this morphing from
Speaker 1: investments going from primarily balance sheet related to now income
Speaker 1: statement related. And so now we have all these ideas
Speaker 1: about capital life businesses and so forth. Well, in a
Speaker 1: sense they're capital life because there's not a lot of
Speaker 1: stuff recorded on the balance sheet. But it's not like
Speaker 1: they're not investing. They are investing, um. So, so that
Speaker 1: just where it shows up is different. Not the concepts
Speaker 1: behind investing doesn't change, but where it shows up. It
Speaker 1: is quite amazing that because of an accounting rule change,
Speaker 1: the way investors can think about a whole bunch of
Speaker 1: companies automatically changes because the investors are trying to gauge
Speaker 1: future profitability, I guess, and all of that comes down
Speaker 1: to the numbers that are presented on the earnings statement.
Speaker 1: Can you maybe elaborate a little bit on on how
Speaker 1: you see those accounting quirks changing or affecting investor behavior.
Speaker 1: So it's a great question tracing. And the first thing,
Speaker 1: and there's obviously a lot of chatter about this and
Speaker 1: the accounting community and so forth. The first thing I'll
Speaker 1: just say is just to keep our eye on the
Speaker 1: ball here, is that, notwithstanding all the adjustments you want
Speaker 1: to make, free cash flow, which is sort of the
Speaker 1: lifeblood of corporate valuation, which is really ultimately the cash
Speaker 1: in versus the cash out, free cash flows perturbed by
Speaker 1: these adjustments, so that doesn't really make any difference. And
Speaker 1: one of the reasons, you know, I opened the report
Speaker 1: with sort of this uh, you know, choice between two
Speaker 1: different investments. Of course it was the same company and
Speaker 1: one it was Walmart. But one showed you know, sort
Speaker 1: of the steady profitability and and and actually growing a
Speaker 1: very nice clip and so forth, and the other showing
Speaker 1: you know, rising dead and dwindling cash balances and so forth.
Speaker 1: And the key to Walmart was that it was this
Speaker 1: is from the early nineteen seventies through the mid nineteen
Speaker 1: eighties at Walmart was profitable but had negative free cash
Speaker 1: flow rights. And all that means is they were investing
Speaker 1: more than they earned. And since their investments were really
Speaker 1: high return, you know, you want them to do that
Speaker 1: you knock yourself out. That's fantastic. So now you say,
Speaker 1: a very similar company with also negative free cash flow,
Speaker 1: but investing on the income state would show losses on
Speaker 1: the right, they would show losses on the income statement,
Speaker 1: and we all sudden say that that doesn't look good.
Speaker 1: So um, so I think that there already there are
Speaker 1: sort of all this ongoing discussion about are there things
Speaker 1: we should do to change the nature of our accounting.
Speaker 1: The one, you know, the obvious one is research and development. Um.
Speaker 1: By the way, the other thing is interesting is this
Speaker 1: does happen in mergers and acquisitions. Right, So if you
Speaker 1: built a great company that has a wonderful brand and
Speaker 1: a great customer list and so forth, and my company
Speaker 1: acquires yours, all of a sudden those that there will
Speaker 1: be some good will, but the intangibles will reflected on
Speaker 1: my balance sheet and then I'm gonna admortise them over
Speaker 1: some period time, so they get acknowledged, but only in
Speaker 1: mergers and acquisitions, and they just don't get acknowledged and
Speaker 1: sort of day to day. So that's the ongoing discussion.
Speaker 1: Now I'm not going to wait around for accountants to
Speaker 1: change the rules. There it's a very conservative bunch, and
Speaker 1: I think I'm sympathetic to them being conservative. And my
Speaker 1: argument is the that that investors need to get on
Speaker 1: this without whether or without the accountants. The other thing
Speaker 1: that and you guys mentioned this in the opening as well,
Speaker 1: and I'm not going to sort of justified evaluations, but
Speaker 1: I think that the market understands these things, so this
Speaker 1: is not being lost on the market. So in a sense,
Speaker 1: as an investor, making thinking about this whole issue in
Speaker 1: a clearer fashion, I think get you more in step
Speaker 1: with how the markets already operating versus you know, putting
Speaker 1: you ahead of everybody else. Right, So, so the market
Speaker 1: I think has already sniffed this out in a major way.
Speaker 1: So you know, again there are things like you know,
Speaker 1: customer lifetime value calculations and research and development and branding.
Speaker 1: There's there have been for long decades discussions about how
Speaker 1: to treat those from an accounting point of view. And
Speaker 1: again this weird thing about if you're your own company
Speaker 1: versus if you get acquired to get treated differently and
Speaker 1: so forth. So um, yeah, it's an ongoing discussion, but
Speaker 1: I'm saying, like, don't wait around for the accounts to
Speaker 1: make your try to quotes, make your life easier, figure
Speaker 1: it out yourself, right, And that's why I called it
Speaker 1: one job. I'm like, look, this is what you have
Speaker 1: to do. This is that these are the cards that
Speaker 1: have been dealt and play them. So it's like, if
Speaker 1: we look at some software company and it's trading at
Speaker 1: thirty x revenue're like and they're like, that's crazy, it's
Speaker 1: a bubble. And the idea of basically what you're saying
Speaker 1: is not that this approach will necessarily tell you whether
Speaker 1: the stock is a buyer or sell or over valued
Speaker 1: or not, but that at least we can appreciate how
Speaker 1: the market is valuing the company and then from there
Speaker 1: make further do further analysis to say whether it's a
Speaker 1: buyers though. That's right, Joe, and you know that. Um.
Speaker 1: About twenty years ago I published a book called Expectations
Speaker 1: Investing My call through our wrap Board, and the argument
Speaker 1: we made there was, you know what you should do
Speaker 1: is start start with a stock price and the market value,
Speaker 1: and then reverse engineer what has to happen for that
Speaker 1: to make sense. Right, So you might ask the question,
Speaker 1: you know, if it's a software company with sales, be
Speaker 1: in retention so on and so forth, and I still
Speaker 1: think that's a very sensible way. So again, I'm not
Speaker 1: here to defend any valuations for any company, but by
Speaker 1: the same token, and this you're you're exactly right. You
Speaker 1: you in other words, a very high percentage of companies
Speaker 1: of companies listen, companies United States lose money. And if
Speaker 1: you just said to yourself, ge, losing money is bad,
Speaker 1: you maybe throw all those things out and you're not acknowledging,
Speaker 1: And that would be like saying free cash flow negative,
Speaker 1: free cash flow is bad. No, that's not true. It's
Speaker 1: a much more subtle issue. You have to understand that
Speaker 1: the magnitude and return on investments, and only with that
Speaker 1: additional insight will you be able to make a sort
Speaker 1: of measure judgment. I know you just you literally just
Speaker 1: said that you're not here to um to make judgments
Speaker 1: on any particular companies valuation, But could you could you
Speaker 1: maybe give us your opinion on on one of the
Speaker 1: thing stocks or what would the thing stocks look like
Speaker 1: through the framework that you've just um explained to us,
Speaker 1: Like how different does something like an Amazon or an
Speaker 1: alphabet look once you start to factor in things like
Speaker 1: intangibles and research and development. Um So, Tracy, I think
Speaker 1: that the one I feel most comfortable with its Microsoft,
Speaker 1: So that's in the same neighborhood probably, And that's the
Speaker 1: example we used in the report. I'll just underscore again
Speaker 1: this is not an investment. There's no one investment of
Speaker 1: lolagent going on what to suggest. But what we did
Speaker 1: is we went through and made these adjustments. And again
Speaker 1: there's a lot of um A judgment as to how
Speaker 1: to make these adjustments in terms of what items should
Speaker 1: be intangible versus version of regular expense, and what is
Speaker 1: the amortization period and so forth. But we there was
Speaker 1: there's a professor named Charles Holton who had done a
Speaker 1: paper on Microsoft who laid out of frameworks, and we
Speaker 1: just said we're gonna follow the Holton framework. Um So,
Speaker 1: to answer your question more directly, what happened was the
Speaker 1: the UH. The technical term is net opcording profit after
Speaker 1: two tax But basically, think the cash rings of the
Speaker 1: company after these adjustments went up by about fifteen percent
Speaker 1: and the invested capital, so the amount of money invested
Speaker 1: in the business went up by about eight percent. Right.
Speaker 1: So again, when you're make when you reverse these UH
Speaker 1: expenses and put them on the bouncy Two things happen
Speaker 1: to take The obvious one is at earnings go up,
Speaker 1: and second is the amount of capital invested goes up.
Speaker 1: So for my Microsoft, and again MICROSOFT'SFT is a very big,
Speaker 1: very profitable, very successful company, and that was a fifteen
Speaker 1: percent lift to their earnings and about it again, increase
Speaker 1: in their capital. You might imagine quite easily that for
Speaker 1: much smaller company and younger companies and earlier in their
Speaker 1: in their development though, the impact would be even more profound.
Speaker 1: So that gives you some sense. So automatically you start
Speaker 1: to say, well people use historical pe multiples or so forth,
Speaker 1: you know you're just getting you're comparing apples to oranges
Speaker 1: if you start to do those kinds of things or
Speaker 1: take them too seriously. So, just on the example of Microsoft,
Speaker 1: and going back to research and development, you mentioned that,
Speaker 1: you know, Fast by the US Accounting UM Standards Center
Speaker 1: back in the ninet seventies made this decision to expense
Speaker 1: R and D because they wanted to be conservative. When
Speaker 1: you look at research and development today, is it all
Speaker 1: about generating future profits or when it comes to a
Speaker 1: company like Microsoft in a very competitive industry, is some
Speaker 1: of it just about I guess like keeping up and
Speaker 1: maintenance rather than betting on the future. Yeah, suddenly make
Speaker 1: two points. First of all, we talked about this directly
Speaker 1: in the report Tracy. It's a very good question. Um.
Speaker 1: One way to think about if you just want to say,
Speaker 1: I want a rough way to sort this in my
Speaker 1: own mind is exactly what you said, which is like,
Speaker 1: how do I think about what's an investment versus what
Speaker 1: is necessary to run? It's precisely that, so say to yourself,
Speaker 1: and you might you know, this would be a great
Speaker 1: question for executives, right, you say, all right, what's spending
Speaker 1: on our income statement and specifically selling general administrative costs?
Speaker 1: What spending do we need just to keep this thing going? Right,
Speaker 1: We'll call that maintenance. And then what spending is truly discretionary,
Speaker 1: that is in pursuit of growth, and that we'll call
Speaker 1: it value creating growth. Right, So that segregation is really
Speaker 1: just a simple way to think about this. And um,
Speaker 1: as I mentioned in the Holton and usually people talk
Speaker 1: about this for R and D, they often will make
Speaker 1: it intangible and you know, for like a young pharmaceutical
Speaker 1: company or biotakers, and that's probably that's probably reasonable, but
Speaker 1: very much to your point with the argument, and we
Speaker 1: draw this out in the report. But for large, older,
Speaker 1: more established digital companies, it makes sense that a chunk
Speaker 1: and maybe even a meaningful chunk of R and D
Speaker 1: is just in quotes maintenance, right. So you know, when
Speaker 1: you get your automatic Windows updates on your computer, a
Speaker 1: lot of that spending to support that was in R
Speaker 1: and D. That's not that's not you know, discretionary, that's
Speaker 1: something they have to do just to maintain the current business.
Speaker 1: So so you're exactly right. So again lots of judgment
Speaker 1: required here. Um, it's more relevant for older and more
Speaker 1: established companies than the younger ones, but you're exactly right,
Speaker 1: that's that you have to And so that the big
Speaker 1: broad defining differential is probably this what do I need
Speaker 1: to spend to maintain versus what am I spending that
Speaker 1: discretionary to grow in the future. So I want to
Speaker 1: just get back to for people who maybe aren't as
Speaker 1: familiar with accounting terminology, just some of the words and
Speaker 1: ideas that we're discussing, including the idea of expensing investments.
Speaker 1: So just to help people can acceptualize it, let's say
Speaker 1: company builds one billion dollar factory, uh, and it's expected
Speaker 1: to be in production for twenty or thirty years. And
Speaker 1: so they spend a billion dollars, but that becomes a
Speaker 1: one billion dollar asset that they have on their balance sheet,
Speaker 1: and then over time that depreciates and they get some
Speaker 1: sort of that affects their income and taxes and so forth.
Speaker 1: Two questions that come to mind, So, hey, just is
Speaker 1: that the right framework? B How is it different? Um
Speaker 1: if they if a company, say, spends one billion dollars
Speaker 1: on building a brand, how does that look? And how
Speaker 1: in the accounting framework do you adjust for the fact that, Look,
Speaker 1: if you build a one billion dollar factory, that factory
Speaker 1: is probably never gonna be worth more than one billion too.
Speaker 1: But if you spend a billion dollars over time, say
Speaker 1: building up a brand, that could become a ten billion
Speaker 1: dollar brand over time if it catches fire. Let's just
Speaker 1: be methodical about this. So the factory, as you said,
Speaker 1: you spend a billion dollars, that goes on your your
Speaker 1: balance sheet it and it's gonna be net property, plant equipment,
Speaker 1: and then you're going to depreciate that over time and
Speaker 1: so usually and that would be twenty years and what
Speaker 1: investors would see a straight lined appreciation, so literally it
Speaker 1: would then be reflected as an expense on the income statements.
Speaker 1: A would flow through the income statement, but again a
Speaker 1: relatively small five percent, right, it's a twenty years of
Speaker 1: life five percent shows up on your concert each year
Speaker 1: and predominantly shows up the bounty. And by the way,
Speaker 1: in the bounty, you're also reducing the value by that
Speaker 1: appreciate depreciation amount. Now that value that asset could be
Speaker 1: worth more. I mean, presumably if you build this billion
Speaker 1: dollar asset and does INCREDI incredibly profitable, and you sold
Speaker 1: it to somebody else, they would they would pay for
Speaker 1: that profitability. So it could be worth more than a
Speaker 1: billion dollars. But as you point out, you know, it's
Speaker 1: hard to it's often not gonna be five or ten
Speaker 1: times that amount. Um. If you're building a brand and
Speaker 1: you're spending a billion dollars, and usually you wouldn't do
Speaker 1: it all in one fell swoop, right, you do it
Speaker 1: over time. But those let's just use things like marketing,
Speaker 1: right or advertising, those are going to be expensed, and
Speaker 1: so the of the cost of that that particular period
Speaker 1: well bill reflected on the income statement and it just
Speaker 1: goes away, right, you never see, there's no recorded value
Speaker 1: for it, and so you might imagine, you know, like crazy,
Speaker 1: you know, you spend your your young company to spend
Speaker 1: you blow your whole advertising budget on December thirty one
Speaker 1: of a year, right, and what the accounts that say
Speaker 1: is that value that things worth nothing? But of course
Speaker 1: the next day hopefully you get some positive benefits from that.
Speaker 1: So just you can see the absurdity of it from
Speaker 1: that from that particular point of view. And as you said,
Speaker 1: as you now again where you know, sort of the
Speaker 1: litmus test for the virtues of doing this is in
Speaker 1: mergers and acquisitions. So if you build you know, Joe Ink,
Speaker 1: and you build this great brand, and my company tries
Speaker 1: to take over your company, I'm gonna pay you for
Speaker 1: those benefits that you've built where you've accrued, and that
Speaker 1: will show up then on my balance sheet. Right, so
Speaker 1: in the sense if there's a transaction, it will show up.
Speaker 1: But in the normal course of business, in terms of
Speaker 1: how you built the business, it would not. So that's
Speaker 1: and again you know, if we keep our eyes on
Speaker 1: the cash flows, we're gonna be fine. But this these
Speaker 1: are really these can be very significant. And obviously the
Speaker 1: reason we're having this conversation today is because you go
Speaker 1: back in time. I mean in nine in nine seventies,
Speaker 1: for example, tangible investments were doubled those of intangible investments,
Speaker 1: and today intangible investments are one and a half times
Speaker 1: tangible investments. So we've seen in a couple of generations
Speaker 1: a real flip in the significance of these particular items,
Speaker 1: and that and that distortion again is has to be
Speaker 1: reversed essentially as we think about things as investors. So
Speaker 1: here's something that I'm curious about in this conversation more broadly,
Speaker 1: which is that is there any way to think about
Speaker 1: the value of intangible assets x anti. I mean, we
Speaker 1: can obviously see that a great brand like say Lululemon
Speaker 1: or Adidas or something that's a brand that's an those
Speaker 1: assets throw off incredible amounts of money. Is there any
Speaker 1: way to not just sort of figure out the value
Speaker 1: of intangible assets and red prospect or is it inherently
Speaker 1: something that has to be done only once we sort
Speaker 1: of get a feel for how profitable they are. Well,
Speaker 1: I mean, Joe, I'll try to go to a kind
Speaker 1: of convenient example of this um, but it's it's a
Speaker 1: big one, which is things like um uh, subscription based
Speaker 1: business godnesses. Right, so you think about you know, whatever
Speaker 1: it is, your Netflix subscription or your Verizon or whatever
Speaker 1: it is. Right, And so the classic model to understand
Speaker 1: that is the company has uh they call customer acquisition costs,
Speaker 1: but an acquisition costs today, say we want Joe as
Speaker 1: one of our customers, and we're gonna spend to get
Speaker 1: him more tracy, and we're gonna, you know, to advertising
Speaker 1: or marketing or some sort of promotion, right, so that
Speaker 1: they're gonna absorb an expense to get you onto their
Speaker 1: get you and then over time, you're gonna spend x
Speaker 1: per month and you'll stick around for a period of time.
Speaker 1: And there's right, So that that that's a class example
Speaker 1: is that there are there are big frameworks thinking about
Speaker 1: customer acquisition and lifetime customer lifetime value and companies are
Speaker 1: obviously making estimates of those values as a think about
Speaker 1: how much they're willing to spend to acquire new customers.
Speaker 1: So there's a there's a fairly concrete example where again
Speaker 1: it's still a judgment. You don't really know the answer,
Speaker 1: but people are making those kinds of calls, and so
Speaker 1: I mean that, and you just go right down the
Speaker 1: line of some of the stock today, they're you know,
Speaker 1: things like the Pelotons the World, the Netflix is of
Speaker 1: the world. These are these are really sort of the
Speaker 1: hot issues as investors look at these things is to
Speaker 1: think about how many customers can they sign up with?
Speaker 1: The economics for customer and so forth. That's all this
Speaker 1: kind of stuff that we're talking about. I have a
Speaker 1: slightly weird question, but just going back to the different
Speaker 1: treatment of intangibles when a company does M and A
Speaker 1: versus when it develops them itself. Do you think that
Speaker 1: that that different treatment encourages companies to do more A
Speaker 1: or to to grow via acquisition nowadays given the importance
Speaker 1: of intangibles on to many companies. Um, it's an intriging question, Tracy.
Speaker 1: I actually don't think so. It was not they don't
Speaker 1: think about it at all, But I don't think so.
Speaker 1: I do think that probably most of the M and
Speaker 1: A that relates to these kinds of things is to acquire,
Speaker 1: whether you know, capabilities or particular business lines, um, rather
Speaker 1: than than thinking about the accounting treatment per se. But
Speaker 1: sort of an add on thought though, is that one
Speaker 1: of the the arguments that accountants make as to why
Speaker 1: they can't or shouldn't be thinking about these intangible assets
Speaker 1: differently than they are today expensing them is that they
Speaker 1: don't really know how to treat them. As that I mentioned.
Speaker 1: Even in my little Microsoft example, there's a lot of
Speaker 1: debate as to what Even in your question about r D,
Speaker 1: there's a lot of debate about how much should be
Speaker 1: considered intangible versus investment, versus maintenance and so forth, and
Speaker 1: then hamortization periods. These are all up debate. But it
Speaker 1: turns out that when there's an M and a deal,
Speaker 1: those things happen. Right There are intangible assets that are
Speaker 1: put onto the balance sheet of the acquirers and those
Speaker 1: are amortized over some period of time. So those judgments
Speaker 1: are being carried out by somebody now. So that's the
Speaker 1: other instring point. But I don't I don't think it's
Speaker 1: a motivator for him and a per se. There are
Speaker 1: a lot of other things that are interesting that would
Speaker 1: be that that that come into play there. But um,
Speaker 1: but it does show you that at least uh in
Speaker 1: that setting, those judgments are being made by accountants right now.
Speaker 1: So in the in the intro, we talked about this
Speaker 1: idea of can a rethinking of accounting sort of rescue
Speaker 1: value investing And so in other words, instead of value
Speaker 1: investors sort of waiting around for maybe bank stocks or
Speaker 1: energy stocks to catch fire, that the sort of the
Speaker 1: whole field can sort of be salvage by just rethinking
Speaker 1: the screens. What counts is value? Where do you stand
Speaker 1: on that? And is that cheating? Is that a legitimate thing? Like?
Speaker 1: How significant is this? And if sort of more people
Speaker 1: appreciated this point, would sort of would there be a
Speaker 1: role for people who come at investing from a quote
Speaker 1: value mentality to thrive even in this environment? You know,
Speaker 1: And Joe, you put your finger on just another very
Speaker 1: hot topic. Um I should mention one of you know,
Speaker 1: one of my UH side things is I'm an adjunct
Speaker 1: professor at Columbia Business School and I'm part of the
Speaker 1: power and Center for Grandma Dot Investing, so very much
Speaker 1: part of that value investing tradition. And I think that
Speaker 1: one of the things just to keep our eye on
Speaker 1: is to think about is to pose the question what
Speaker 1: is value investing? And I think you said this even
Speaker 1: Joe in the introduction there are two ways to think
Speaker 1: about it. One is buying something for less than what
Speaker 1: it's worked, and then the second is um and this
Speaker 1: was I think very much popularized in with with Gene
Speaker 1: Common and con French paper. Is a statistical factor, that's right,
Speaker 1: so the low price to book, low price to hurtings
Speaker 1: and so forth. So the first definition of value investing
Speaker 1: hasn't gone away at all. Find something for listening to
Speaker 1: worth that you know, and we could have a conversation
Speaker 1: ten years from our hundred years from now, and and
Speaker 1: I'm hopeful that we still have the same definition. The
Speaker 1: statistical factors, though, is the one I think that's been
Speaker 1: under prunture to some degree, and so there has been
Speaker 1: a slew of research. By the way, there are people
Speaker 1: counter this, but there's been I think the balance of
Speaker 1: the research would suggest that with adjustments as we've described,
Speaker 1: and obviously when you're talking about lots and lots of companies,
Speaker 1: you have to use fairly blunt instruments. But even with
Speaker 1: those blunt instruments, those adjustments allow you to get better signals.
Speaker 1: So I will draw your attention to a very astream
Speaker 1: paper about value investing by Brooke lev and a Nucro
Speaker 1: Bostava and it made the rounds, you know, came on
Speaker 1: the fall last year, and they revised in the spring
Speaker 1: of this year, and they made a couple of points
Speaker 1: that we're really interesting. One is, if you make these adjustments,
Speaker 1: the companies that fall into those categories of glamour, which
Speaker 1: is high high valuation versus value, which is low valuation,
Speaker 1: the companies in those categories shuffle all around, right, so
Speaker 1: like a substantial percentage fall out of those those bins.
Speaker 1: And the second is the signal you get from this
Speaker 1: value factor buying cheap things actually improves, they believe improved
Speaker 1: quite markedly when you introduce these kinds of adjustment. So
Speaker 1: this this debate, and again again there may be there's
Speaker 1: there may be a more overarching themes about value that
Speaker 1: the value factor, as we know, all factors, by the way,
Speaker 1: tend to be epistodic. Can value investing coexist with the
Speaker 1: efficient market hypothesis? This is something I've always wondered. But
Speaker 1: if you assume that the market does a reasonably good
Speaker 1: job of allocating capital to um companies that show good potential,
Speaker 1: then like, what is value investing actually doing? Isn't it
Speaker 1: just cast like basically saying that the market is wrong
Speaker 1: at any point in time. Well, definitely, um, you know,
Speaker 1: so just to take a step back, there's no you know,
Speaker 1: the markets can't be perfectly efficient, right, because there's a
Speaker 1: cost of gathering information every flec. The crisis is a consequence.
Speaker 1: There always has to be some sort of access return.
Speaker 1: Las Peterson calls this. You know, markets are efficiently inefficient, right,
Speaker 1: so there has to be enough to keep people trying
Speaker 1: to do this thing now, value investing. If you go
Speaker 1: to sort of the academic community, there's a debate about
Speaker 1: what is at the court here, and there's sort of
Speaker 1: two different camps. The first camp is ge this is
Speaker 1: just you know, value. The value factor is just compensation
Speaker 1: for risk. So our traditional models for measuring risk, which
Speaker 1: is usually based on the capitalistic pricing models, the measure
Speaker 1: of volatility, we're just not capturing something that's important, and
Speaker 1: by introducing the value factor, we're now more completely capturing risk.
Speaker 1: The second camp, where I think the balance of the
Speaker 1: evidence lies by the way I think it's here, is
Speaker 1: that there are behavioral factors and so as human beings,
Speaker 1: we tend to go to we over extrapolate, and we
Speaker 1: tend to go to accesses, both on the greed and
Speaker 1: fear side. There's a consequence from time to time things
Speaker 1: become inefficiently priced in the sense that they're you know,
Speaker 1: they're they're fundamentals are not as strong as are off
Speaker 1: versus of their expectations. So that, I mean, I'm not
Speaker 1: sure that that debate has resolve, but the premise of
Speaker 1: that at least. So so you have to put yourself
Speaker 1: in one of those two camps. And maybe it's a
Speaker 1: blend of the two. But if you believe in the
Speaker 1: behavioral thing. Now I'll just say my own personal view
Speaker 1: is of that, Uh, you know, one thing that has
Speaker 1: not changed, we could, of all the accounting stuff, we
Speaker 1: want one thing that has not changed, just the nature
Speaker 1: of human behavior, right, So, and I think that's a
Speaker 1: very hard thing for us to change. And so I
Speaker 1: suspect many of the kinds of patterns we've seen in markets,
Speaker 1: and which by the way, are not novel today. They've
Speaker 1: been around for literary centuries. Um I would anticipate would
Speaker 1: continue to be the kinds of patterns we see, at
Speaker 1: least for the foreseeable future. No one serious has ever
Speaker 1: claimed that they have are perfectly efficient because they can't
Speaker 1: be um. But but I think that would be how
Speaker 1: I would think about value, the value piece of that.
Speaker 1: I have one more questions. So I know we've been
Speaker 1: thinking a lot about the big text stocks in this conversation,
Speaker 1: but I guess I have two questions actually, So one
Speaker 1: does the emphasis on intangible assets, you know, things that
Speaker 1: we can't see or feel, things like brand value where
Speaker 1: you really have to put a lot of forecasting and
Speaker 1: estimates into figuring out how much something like that is worth.
Speaker 1: Does that make it even trickier to value a company nowadays?
Speaker 1: Is there is there a likely more of a likelihood
Speaker 1: that we get it wrong? And secondly, when it comes
Speaker 1: to something like the textocks, what should investors be looking
Speaker 1: out for to see whether or not prices have truly
Speaker 1: overshot the future value of the company, even when including
Speaker 1: things like intangibles? Right, so on the on the first
Speaker 1: discussion is you know, is it trickier to do this
Speaker 1: what I always like to do as an investors break
Speaker 1: things down to what I would call the basic unit
Speaker 1: of analysis, which is how does this company basically make money?
Speaker 1: And thinking about that as carefully as possible. Now, you know,
Speaker 1: you sort of mentioned some of these things seem like
Speaker 1: they're more abstract to some degree, but look, a lot
Speaker 1: of intangibles. You know, your pharma super company develop a
Speaker 1: new uh, it's not you know, that's and it's got
Speaker 1: a patent for example, that's not that's not abstract, Like
Speaker 1: that's pretty clear and that's got value and that you
Speaker 1: can model those things pretty accurately, or customer lifetime value calculations.
Speaker 1: You know, we can debate about the details, but the
Speaker 1: basic framework seems to make a lot of sense. So
Speaker 1: can they be more difficult? Perhaps? Um? I think the
Speaker 1: bigger issue that comes up is this idea and Nen
Speaker 1: do me. They call it sunkenness, which is if you
Speaker 1: develop intangible assets for your own company, they may be
Speaker 1: less transferable, so the harder value in that way. But no,
Speaker 1: for the most part, I think that it's the same
Speaker 1: basic story. And then on the tech stocks or you know,
Speaker 1: just in general, like how do we know that we're overpaying?
Speaker 1: That's where I would go back to this expectations approach.
Speaker 1: And again I have no answers about a specific company
Speaker 1: or even the market today, but I would just say
Speaker 1: that it is important to say what has what what
Speaker 1: do I have to believe for this thing to makes sense, right, Michael,
Speaker 1: that was that was great. I really appreciate you joining us.
Speaker 1: Always a pleasure and fascinating stuff. Really helpful to sort
Speaker 1: of think through what these things mean in a concrete way.
Speaker 1: My pleasure guy thinks as always loved the questions and
Speaker 1: I love the conversation. Thanks, Michael. I found that really helpful, Tracy.
Speaker 1: I mean, you know, I I this idea that intangible
Speaker 1: assets has grown in importance. It's sort of obvious. Everyone
Speaker 1: can figure it out. You look at, you know, the
Speaker 1: companies that are really valuable, and you sort of recognize
Speaker 1: that they're not the sort of factory heavy companies of
Speaker 1: your But how that actually fits into a sort of
Speaker 1: valuations framework, I thought Michael explained really well. Yeah. I
Speaker 1: also liked his idea of looking at a basic unit
Speaker 1: of analysis, so how does the company actually make money
Speaker 1: and sort of zero in all that um to determine
Speaker 1: how important or how much of a return you would
Speaker 1: get on investment for a particular company. So, you know,
Speaker 1: I guess if you're if you're operating like a retailer,
Speaker 1: then your investment from creating a new store is going
Speaker 1: to be very different from if you're operating a big
Speaker 1: tech company, for instance, and you develop new software, and
Speaker 1: what your investment is, what your return on that particular
Speaker 1: investment is. Yeah, you know, one of the things that
Speaker 1: I sort of as a journalist and thinking about markets
Speaker 1: is obviously markets can be wrong, assets can be overpriced
Speaker 1: or underpriced, and our bubbles and manias and peaks of pessimism.
Speaker 1: But by and large, I think it's a valuable, valuable
Speaker 1: practice to get into the habit of at least trying
Speaker 1: to justify a market value for anything at any given points.
Speaker 1: So you look at something like the pricing on Netflix
Speaker 1: or Tesla or some of these crazy names, and it's
Speaker 1: very easy to just say, like, that's a bubble that's overvalued.
Speaker 1: And they may be, and you know, it's like bubbles
Speaker 1: really do happen. But I really do think that you
Speaker 1: should one should always sort of attempt to sort of
Speaker 1: I guess I would say, see it from the market's perspective,
Speaker 1: even though the market is not a person. And I
Speaker 1: do think that this is a way to get there,
Speaker 1: at least to some extent. With some of these names. Again,
Speaker 1: it's it's not to say that the markets priced or
Speaker 1: Riot or that they're not overvalued, that they're not going
Speaker 1: to fall, but at least it can sort of you
Speaker 1: can start building a framework of your in your head
Speaker 1: about how some of these valuations might make sense. Now,
Speaker 1: I agree, and I think it's sort of that aspect
Speaker 1: of it is even more important for the undervalued companies
Speaker 1: or you know, this is where I start to think
Speaker 1: that value investing is actually quite arrogant, because is you
Speaker 1: basically think you're smarter than the market and you're sort
Speaker 1: of rooting out companies that the markets view of is wrong. Um,
Speaker 1: I don't know, Like I just I don't want to
Speaker 1: say the market is always right, but like it does
Speaker 1: seem like you're setting yourself up for disappointment if you're
Speaker 1: just sort of like running counter to it all the time. Yeah. No,
Speaker 1: I mean I agree that. You know, another thing I
Speaker 1: was wondering about is like, Okay, so as we established
Speaker 1: that there's sort of two ways to think about value investing,
Speaker 1: there's like the sort of statistical factor, um, which is
Speaker 1: the sort of part that hasn't done so well in
Speaker 1: recent years because if you just look at traditional metrics
Speaker 1: like price to earnings or price to book, companies with
Speaker 1: low multiples they haven't really done well, and I just
Speaker 1: like wonder if, like there will ever be a day
Speaker 1: where everyone sort of froze in the towel, where no
Speaker 1: one's sort of left arguing that it's a good idea
Speaker 1: to buy a stock because it's sort of cheap on
Speaker 1: the traditional metrics, and everyone who considers themselves a value
Speaker 1: investor eventually capitulate and starts coming up with reasons why
Speaker 1: actually Facebook and Netflix and Alphabet are actually value stocks.
Speaker 1: I feel like at some point that's gonna happen. Maybe
Speaker 1: that'll be a major turning point in the market. Yeah,
Speaker 1: I think you're right. I keep thinking the last value
Speaker 1: Investors Standing would be a really good title for a
Speaker 1: book or or some sort of like short fiction story
Speaker 1: or something like that. We should write it. Basically, everyone
Speaker 1: is just going to own software and one person is
Speaker 1: going to own all the banks in oil companies that
Speaker 1: there's a last one to do it, they'll probably do well,
Speaker 1: that's right, and they're like camping out on a hill somewhere. Um, alright, yeah,
Speaker 1: I like that. We should make a short film about it. Okay,
Speaker 1: so we leave it there, Yeah, I say it there. Alright.
Speaker 1: This has been another episode of The All Thoughts Podcast.
Speaker 1: I'm Tracy Alloway. You can follow me on Twitter at
Speaker 1: Tracy Alloway, and I'm Joe Why Isn't Thal? You can
Speaker 1: follow me on Twitter at the All work and you
Speaker 1: should follow our guest Michael Mobison on Twitter. His handle
Speaker 1: is m J Mobison. Follow our producer Laura Carlson. She's
Speaker 1: at Laura M. Carlson. Follow the Bloomberg head of podcast,
Speaker 1: Francesca Levi at Francesca Today, and check out all of
Speaker 1: our podcasts at Bloomberg under the handle at podcast. Thanks
Speaker 1: for listening.