WEBVTT - Everything You've Been Taught About How to Value a Stock Might Be Wrong 0:00:09.280 --> 0:00:13.240 Hello, and welcome to another episode of the All Thoughts podcast. 0:00:13.280 --> 0:00:17.440 I'm Tracy Allaway and I'm Joe Wisenthal. So, Joe, we 0:00:17.480 --> 0:00:21.200 are in the midst of yet another earning season, which 0:00:21.239 --> 0:00:25.360 means everyone is spending their time examining all the income 0:00:25.440 --> 0:00:29.120 statements that big companies are publishing. Right. Yeah, it comes 0:00:29.600 --> 0:00:32.040 four times a year, and it's one of the you know, 0:00:32.120 --> 0:00:34.440 one of the most exciting times of the year, especially 0:00:34.440 --> 0:00:37.879 if you're a stock investor, because it's when you know, 0:00:37.960 --> 0:00:41.200 the companies reveal all of the stuff that they did 0:00:41.280 --> 0:00:44.760 in the last quarter, the revenue, how much they made, 0:00:45.360 --> 0:00:48.320 how much their balance sheet, highlights of the quarter, and 0:00:48.320 --> 0:00:50.680 it's when you really have a chance to dig in 0:00:50.760 --> 0:00:53.519 because you have a fresh snapshot of the state of 0:00:53.520 --> 0:00:56.200 the company. Right. But there's a lot of work that 0:00:56.240 --> 0:01:01.639 goes into estimating earnings results even before they come out, right, Like, 0:01:02.160 --> 0:01:05.679 analysts will be tweaking their models ahead of results season, 0:01:05.760 --> 0:01:08.240 and then they'll be tweaking them after. Everyone is sort 0:01:08.240 --> 0:01:11.039 of digging into the numbers to try to determine how 0:01:11.040 --> 0:01:14.480 well or how badly a company is doing. Absolutely, and 0:01:14.520 --> 0:01:16.160 one of the things that I think a lot of 0:01:16.200 --> 0:01:19.280 people don't get if they're not really active in markets. 0:01:19.280 --> 0:01:22.760 Is that there's no such thing is objectively good or 0:01:22.800 --> 0:01:28.520 bad earnings, because in markets everything is about relative to expectations. 0:01:28.520 --> 0:01:31.800 So you can have a company that doubled their earnings 0:01:32.000 --> 0:01:35.040 and made a billion dollars this year versus a billion 0:01:35.080 --> 0:01:37.360 more than last year, but if the market was expecting 0:01:37.440 --> 0:01:39.720 them to make one point two billion dollars more than 0:01:39.720 --> 0:01:42.600 the stock might tumble. Conversely, you can have companies that 0:01:42.920 --> 0:01:46.399 lose a ton of money, but if people were impressed 0:01:46.400 --> 0:01:48.720 by some you know, their revenue growth, or people were 0:01:48.760 --> 0:01:52.080 impressed that they were expected to lose more, uh, they 0:01:52.280 --> 0:01:55.360 the stock might surge. And as such, it's the sort 0:01:55.360 --> 0:01:58.720 of like the classic kynesie and beauty contest. You don't 0:01:58.800 --> 0:02:01.000 just try to figure out the company is gonna earn, 0:02:01.240 --> 0:02:03.240 but we also try to figure out what the crowd 0:02:03.480 --> 0:02:05.920 thinks the company is going to earn and how the 0:02:06.000 --> 0:02:09.919 actual results match up to expectations. Right, And some people 0:02:09.919 --> 0:02:12.840 say that things have gotten even more complicated in recent 0:02:12.919 --> 0:02:15.560 years because you have companies that sort of try to 0:02:15.639 --> 0:02:19.760 talk down expectations before their results and so inevitably they 0:02:19.880 --> 0:02:24.880 end up beating already low forecasts. So there's lots of 0:02:24.919 --> 0:02:27.200 moving parts to this isn't there. But Joe, what if 0:02:27.200 --> 0:02:31.640 I told you that digging into earnings is a useless exercise. 0:02:31.880 --> 0:02:34.399 If you told me that it was a useless exercise 0:02:34.440 --> 0:02:37.040 to dig in like this, I would be completely crushed 0:02:37.080 --> 0:02:39.520 because a part of my job is to talk about 0:02:39.560 --> 0:02:42.560 this and be One of my first jobs was doing 0:02:42.600 --> 0:02:46.480 equity research for a small portfolio management company, and that's 0:02:46.520 --> 0:02:49.360 what I spent hours and hours going through every one 0:02:49.400 --> 0:02:53.280 of these lines. So please don't tell me now. I'm 0:02:53.280 --> 0:02:55.640 sorry to get scared. Why are you? Why are you 0:02:55.760 --> 0:02:59.000 hinting that maybe it's all the waste of time? Don't 0:02:59.000 --> 0:03:01.360 be scared, Joe. What I mean is it might be 0:03:01.480 --> 0:03:05.600 useless to dig into those earning statements in a sort 0:03:05.639 --> 0:03:09.119 of traditional sense. Basically, there are some people out there 0:03:09.120 --> 0:03:13.320 who think that the way we use current accounting rules 0:03:13.320 --> 0:03:16.320 are the way that accounting rules have been implemented, doesn't 0:03:16.360 --> 0:03:21.000 really match the realities of our modern economy or our 0:03:21.200 --> 0:03:26.720 modern business environment. Okay, so let's get your I'm still 0:03:26.760 --> 0:03:29.079 a sort of waiting for the build up here. You'll 0:03:29.120 --> 0:03:32.440 be fine, You'll be fine. Okay, We're going to talk 0:03:32.560 --> 0:03:36.480 to Baruke Love. He's professor of Accounting and Finance at 0:03:36.480 --> 0:03:40.800 Stern School of Business and Fenggu Associate Professor of Accounting 0:03:40.800 --> 0:03:43.920 at Sunni Buffalo. They put out a paper which was 0:03:44.000 --> 0:03:49.080 fantastic on this exact subject, basically arguing that our accounting 0:03:49.280 --> 0:03:53.000 standards haven't really kept up with big, big changes that 0:03:53.080 --> 0:03:55.720 have overtaken the economy in recent years. So let's get 0:03:55.720 --> 0:03:58.680 over to them. Buruke and Fang, welcome to the show. 0:03:59.040 --> 0:04:01.960 Thank you, thank you, Thank you for having us. So 0:04:02.360 --> 0:04:05.800 was that intro accurate? Is the some of your work 0:04:06.080 --> 0:04:12.360 essentially that accounting methodology hasn't really adjusted to modern realities. 0:04:13.000 --> 0:04:15.880 I would say the intro is very accurate. It's not 0:04:16.000 --> 0:04:21.520 just that we claimed that earnings don't matter. We actually 0:04:21.680 --> 0:04:25.839 prove it. Uh. In a recent article we published, we 0:04:26.000 --> 0:04:29.039 show for all companies that even if you had the 0:04:29.240 --> 0:04:34.799 dream forecasting machine, meaning that you could focus, you could 0:04:34.839 --> 0:04:40.640 identify all the companies that we meet or beat consensus 0:04:40.680 --> 0:04:45.480 analysts focused next quarter. You're not longer to make anybody. 0:04:45.720 --> 0:04:48.159 You're not going to make any money from this. You 0:04:48.440 --> 0:04:52.479 used to in the past, big money, but no longer. 0:04:52.640 --> 0:04:57.960 And most people are not aware of the demise of 0:04:58.160 --> 0:05:05.360 earnings as an indicate of company performance. Evaluated of manager's capabilities. 0:05:05.920 --> 0:05:09.239 So we actually prove it both in a recent book 0:05:09.279 --> 0:05:14.120 that we wrote and in in the article. And this 0:05:14.240 --> 0:05:17.960 is this is really I would say earth shattering, but 0:05:18.200 --> 0:05:21.760 it's effect. This is indeed earth shattering. I mean, this 0:05:21.839 --> 0:05:24.480 is in fury. This blows up the premise of so 0:05:24.520 --> 0:05:27.560 many of our conversations, which as we say, okay, Facebook 0:05:27.560 --> 0:05:30.400 earnings are coming out, or GM earnings are coming out, 0:05:30.520 --> 0:05:32.800 and they're expected to earn a dollar and a penny 0:05:32.800 --> 0:05:35.560 per share, and they earn only nineties seven cents. And 0:05:36.080 --> 0:05:38.960 as you say, we try so hard to get this right. 0:05:39.600 --> 0:05:41.440 Let's say, maybe let's start from thinking, so, where did 0:05:41.440 --> 0:05:44.479 the if it's not right, where did it come from? 0:05:44.480 --> 0:05:46.480 Where did we get this idea of how we traditionally 0:05:46.520 --> 0:05:50.599 talk about earnings. The centrality of earnings comes from the 0:05:50.680 --> 0:05:55.080 work of Graham many years ago. He was the celebrated 0:05:55.120 --> 0:05:59.200 teacher of warm Buffett, and since then earnings are the 0:05:59.440 --> 0:06:04.720 center of all the models that analysts are using. Everything 0:06:04.839 --> 0:06:10.880 is aimed at predicting forthcoming earnings. Managers are pestor to 0:06:11.040 --> 0:06:17.159 provide some guidance for forecasting earnings. Everything revolves around earnings, 0:06:17.360 --> 0:06:19.839 and the reason, of course, a reason why so many 0:06:19.839 --> 0:06:23.520 so much money goes to index fund and to automated 0:06:23.720 --> 0:06:29.200 investment managed funds are not doing well, and we claim 0:06:29.279 --> 0:06:31.599 that the main reason why they're not doing well is 0:06:31.680 --> 0:06:37.080 because their focus on earnings is completely misplaced. Right, And 0:06:37.160 --> 0:06:40.240 you have, like you said earlier, if if someone built 0:06:40.279 --> 0:06:45.080 the perfect earnings prediction machine, there was a time when 0:06:45.240 --> 0:06:47.800 you could have made big money from that, and now 0:06:47.839 --> 0:06:51.680 it doesn't seem to be the case. So what exactly 0:06:51.760 --> 0:06:55.240 has happened there? What happened is that it used to 0:06:55.320 --> 0:06:59.880 be that earnings really indicated performance of companies. Thirty forty 0:07:00.040 --> 0:07:07.000 years ago, earnings basically indicated revenues minus real costs. Since then, 0:07:07.200 --> 0:07:11.640 there was a revolution in the business models of companies 0:07:12.440 --> 0:07:16.840 from tangible to intangible assets. You don't make money anymore 0:07:16.960 --> 0:07:21.400 from machines and equipment and building. You make money from 0:07:21.520 --> 0:07:27.920 patents and brands and information technologies and human resources. Everyone 0:07:28.040 --> 0:07:32.080 knows it, everyone uses it, except for accountants that were 0:07:32.120 --> 0:07:35.680 really asleep at the wheel and still are. And all 0:07:35.760 --> 0:07:41.280 those huge expenses of companies in intangibles are expensed in 0:07:41.400 --> 0:07:46.120 the income statement, meaning they are charged against earnings. So 0:07:46.200 --> 0:07:51.200 the earnings that you get today are completely misstated. For 0:07:51.280 --> 0:07:55.800 some companies, they are overstated. For other companies they are understated. 0:07:56.560 --> 0:07:59.320 Just think about the Amazon in the last four or 0:07:59.360 --> 0:08:05.480 five years, they missed half their consensus earnings. Nothing happened 0:08:05.480 --> 0:08:08.120 to them. That's of course a marvelous companies with a 0:08:08.240 --> 0:08:15.240 huge market value. Think about Tesla, incredible brand, with accumulated 0:08:15.360 --> 0:08:19.320 losses of one and a half billion dollars because they 0:08:19.320 --> 0:08:23.800 are forced to expense all their investments. A much smaller, 0:08:23.960 --> 0:08:28.480 less known company like Kite Farmer, which works on very 0:08:28.520 --> 0:08:34.640 advanced cancer research. You look at the financial reports accumulated 0:08:34.760 --> 0:08:38.040 losses of six hundred million dollars. They were just a 0:08:38.080 --> 0:08:42.280 week ago bought by gilly Out Sciences for twelve billion dollars. 0:08:43.040 --> 0:08:48.920 I mean, the financial reports completely mistaked the picture of 0:08:49.040 --> 0:08:54.000 the company, the performance of the company, the future prospects 0:08:54.160 --> 0:08:57.800 of the company. And that's where we are now. And 0:08:57.920 --> 0:09:01.480 that's why, that's the reasons of the failure of the 0:09:01.600 --> 0:09:06.800 traditional analges of companies focusing on earnings. Again, these are 0:09:06.840 --> 0:09:10.560 not just claims that we make article. We demonstrate that 0:09:10.920 --> 0:09:14.160 the lass of earnings relevance over time is really driven 0:09:14.320 --> 0:09:18.400 by companies that invest a lot of money intangible assets. 0:09:18.480 --> 0:09:24.520 So Over time, investors eventually realize that the earnings information, 0:09:24.679 --> 0:09:28.000 the profit laws, and the balance and information investors look 0:09:28.040 --> 0:09:33.080 at is no longer relevant for evaluating the performance and 0:09:33.120 --> 0:09:35.960 the value of these companies. So to be clear, just 0:09:36.000 --> 0:09:39.000 to clarify that a little further, there was a point 0:09:39.160 --> 0:09:41.959 in which that magic earnings oracle would have made you 0:09:42.000 --> 0:09:44.560 a lot of money had you had it. And you 0:09:44.679 --> 0:09:48.720 demonstrate in your paper that the value of that information 0:09:48.880 --> 0:09:51.200 in advance has declined. Can you talk us through a 0:09:51.240 --> 0:09:53.920 little bit that's sort of the quantitative evidence you show 0:09:54.080 --> 0:09:57.680 that that isn't useful information anymore. Sure, Going back to 0:09:57.760 --> 0:10:01.520 the late eighties and early nineties, um, the gains from 0:10:01.559 --> 0:10:06.400 this dream machine of perfectly predicting future earnings would allow 0:10:06.440 --> 0:10:09.960 you to earn access profit in the magnitude of twenty 0:10:10.040 --> 0:10:14.280 five percent each year. This is in access of market 0:10:14.360 --> 0:10:17.600 and risk adjusted returns. So those were the good days 0:10:17.640 --> 0:10:21.800 of playing this earnings prediction game. Now, moving to the 0:10:21.840 --> 0:10:24.800 current time, as off the end of two thousand fifteen, 0:10:25.360 --> 0:10:28.080 the same process would earn you no more than two 0:10:28.080 --> 0:10:31.000 percent of access return. And there are of course a 0:10:31.000 --> 0:10:34.480 lot of treating strategies that can earn you even better 0:10:35.360 --> 0:10:48.680 access returns at much lower cost. Before we get into 0:10:49.200 --> 0:10:50.959 you know, I will obviously I want to talk about 0:10:50.960 --> 0:10:53.720 what we should be looking at instead of the traditional earnings. 0:10:53.720 --> 0:10:56.120 But before we get into that, it's still you know, 0:10:56.160 --> 0:10:59.080 it makes me uncomfortable because even with all of the 0:10:59.240 --> 0:11:03.600 changes in business models an intangible assets, it still seems 0:11:03.640 --> 0:11:06.679 like an intuitive basis that the measure of a company 0:11:06.760 --> 0:11:09.040 is like, okay, but did you make money or not 0:11:09.200 --> 0:11:11.800 in this quarter? And how much money do you have today? 0:11:11.840 --> 0:11:14.560 And how much money do you have three months from now, 0:11:14.679 --> 0:11:17.560 and that ultimately, for as weird and as different as 0:11:17.600 --> 0:11:21.560 business models get, profit is still the point of business. 0:11:21.679 --> 0:11:24.160 It sits in a little bit uneasy with me that 0:11:24.320 --> 0:11:27.559 ultimately it still wouldn't come back to just how much 0:11:27.559 --> 0:11:31.200 money they made. You're right about the importance of how 0:11:31.320 --> 0:11:35.160 much money you're you're making now and of course even 0:11:35.200 --> 0:11:37.600 more important, how much money you'll make in the future. 0:11:38.520 --> 0:11:42.559 What we claim is that earnings measured according to the 0:11:42.559 --> 0:11:48.120 accounting rules today don't even reflect this. That's why, for example, 0:11:48.160 --> 0:11:50.640 in our in our recent book The End of Accounting, 0:11:50.760 --> 0:11:55.480 we show that if you base your analysis on cash flows, 0:11:55.600 --> 0:11:58.160 you will be better off then if you'll do it 0:11:58.240 --> 0:12:01.720 on earnings. So you're perfectly right. It's of course of 0:12:01.760 --> 0:12:06.920 great importance how much money you make, but reported earnings 0:12:07.000 --> 0:12:10.560 don't measure how much money you make by the way 0:12:10.920 --> 0:12:14.880 managers know it, and that's the major reason why they 0:12:14.920 --> 0:12:20.120 release all those non gap earnings which are so derided 0:12:20.280 --> 0:12:24.000 by our people. Some of them are, of course a 0:12:24.080 --> 0:12:28.920 little massage manipulated, but by and large this is a 0:12:29.000 --> 0:12:34.319 manager will response to the inability of currently measured earnings 0:12:34.360 --> 0:12:39.760 to reflect what actually happens in corporations. Right, So it 0:12:39.800 --> 0:12:43.280 feels like every earning season we get a news article 0:12:43.400 --> 0:12:50.400 about how reported gap figures are veering away from adjusted earnings, 0:12:50.440 --> 0:12:54.800 and lots of people have problems with adjusted earnings because 0:12:54.800 --> 0:12:59.760 they think they're they're vulnerable to manipulation either by managers 0:12:59.880 --> 0:13:03.240 or analysts might read too much into them. But you're 0:13:03.360 --> 0:13:08.600 arguing that there are more accurate representation than traditional gap accounting, 0:13:08.880 --> 0:13:12.720 or that they feel a sort of gap left by gap. 0:13:13.000 --> 0:13:17.480 I guess again, it's not. It's not just my argument. 0:13:18.840 --> 0:13:22.840 It's the result of lots of research projects that are 0:13:22.920 --> 0:13:29.880 confirmed that investors react more strongly, most forcefully to non 0:13:30.000 --> 0:13:36.479 gap earnings than gap earnings. So investors find by enlarge, 0:13:36.720 --> 0:13:41.439 non gap earnings is much more informative than gap earnings. 0:13:41.559 --> 0:13:44.760 That's again effect. These are things that are very easy 0:13:44.800 --> 0:13:48.679 to research, and these are the findings. Thing I think 0:13:48.920 --> 0:13:53.120 you mentioned Amazon, or maybe we're talking about Amazon and Tesla, 0:13:53.760 --> 0:13:57.520 and of course Amazon is sort of famous for people 0:13:58.200 --> 0:14:02.280 discarding their earnings or even their non gap earnings that 0:14:02.400 --> 0:14:04.559 you can have these quarters will they'll lose money and 0:14:04.600 --> 0:14:08.439 the stock shoots up, or they'll give a guidance range 0:14:08.520 --> 0:14:10.960 that's so wide is to be laughable, but it doesn't 0:14:11.000 --> 0:14:14.240 really matter to people, and people keep buying. The story 0:14:14.679 --> 0:14:18.280 that pundits like to tell about Amazon is that Jeff 0:14:18.320 --> 0:14:22.080 Bezos has done such a good job training Wall Street 0:14:22.120 --> 0:14:25.480 to not care about quarter to quarter profits that they 0:14:25.480 --> 0:14:29.400 can get away with huge investments and huge losses from 0:14:29.400 --> 0:14:32.160 time to time. But it sounds like what you guys 0:14:32.160 --> 0:14:35.160 are saying is that the way we characterize Amazon is 0:14:35.160 --> 0:14:38.280 a little too pat and that actually Wall Streets response 0:14:38.400 --> 0:14:41.400 is not about some training or anything like that, but 0:14:41.600 --> 0:14:45.960 essentially about investors just sort of understanding, like in any company, 0:14:46.280 --> 0:14:48.720 the numbers that really matter, and that earnings aren't really it. 0:14:49.360 --> 0:14:52.640 That's that's absolutely true. So what we have advocated in 0:14:52.720 --> 0:14:54.840 a book as well as the article, is this notion 0:14:55.280 --> 0:14:59.200 of strategic assets. What really matters to accompany success and 0:14:59.240 --> 0:15:02.960 the competitive at UH is not just current quarters earnings 0:15:02.960 --> 0:15:06.840 of profit. It's UH their strategic asset that give them 0:15:06.880 --> 0:15:10.640 long term value in market competition. So for a company 0:15:10.720 --> 0:15:15.040 like Amazon, what investment has delivered to them is the 0:15:15.120 --> 0:15:17.760 growth of their strategic asset. If you think about their 0:15:17.800 --> 0:15:21.400 market share, their expansion into more and more market territories, 0:15:21.920 --> 0:15:26.120 that's the proof that they're growing their strategic assets very strongly. 0:15:26.400 --> 0:15:28.840 And the investors certainly understand this. At the end of 0:15:28.840 --> 0:15:31.040 the day, they're not just going to look at the 0:15:31.120 --> 0:15:34.480 quotally profit or loss or Instead, they're going to pay 0:15:34.560 --> 0:15:38.320 a lot of attention to amazon strategic assets. All the 0:15:38.400 --> 0:15:42.000 assets have been investment, invested, deployed, and what kind of 0:15:42.080 --> 0:15:45.920 value has been created by these assets. To interject the 0:15:46.000 --> 0:15:49.800 cautionary note here, we are speaking about Amazon and Tesla, 0:15:50.240 --> 0:15:54.120 and investors definitely understand these companies because they are led 0:15:54.120 --> 0:16:00.320 by extremely articulate and charismatic leaders and the men search 0:16:00.560 --> 0:16:04.440 is clear. But there are thousands of companies out there 0:16:04.720 --> 0:16:11.040 without Jeff Bezos and other charismatic leaders that their message 0:16:11.080 --> 0:16:15.000 is not well understood and investors don't see the truth. 0:16:15.080 --> 0:16:18.480 They are still relying on the reported numbers, which are 0:16:18.680 --> 0:16:22.680 misleading them. So that's why I think our message is 0:16:22.720 --> 0:16:27.080 so relevant today. If investors knew everything, we would even 0:16:27.080 --> 0:16:31.240 write this article now, but they are not. It's only 0:16:31.280 --> 0:16:36.440 for a few companies with those very effective CEOs or 0:16:36.480 --> 0:16:40.080 CFOs that can spread this message. The other thing I'm 0:16:40.120 --> 0:16:44.800 wondering is your findings. You know about this perfect earnings 0:16:45.000 --> 0:16:47.960 estimator and the fact that it wouldn't be much of 0:16:48.000 --> 0:16:51.000 an edge in the market nowadays. Does that say more 0:16:51.080 --> 0:16:55.160 about how the market is functioning than the deficiencies of 0:16:55.200 --> 0:16:59.000 the accounting rules themselves, because one of the criticisms of 0:16:59.040 --> 0:17:03.320 the current market is that valuations no longer matter. You know, 0:17:03.400 --> 0:17:07.840 people aren't really investing on fundamental terms. They're just sort 0:17:07.880 --> 0:17:12.199 of following the money and it's all momentum based. So 0:17:12.359 --> 0:17:15.240 you're right, there a lot investing on the fundamentals or 0:17:15.359 --> 0:17:18.720 less than a fewer and fewer people are investing on 0:17:18.800 --> 0:17:22.919 fundamentals because it faces them. I mean, they see the 0:17:23.000 --> 0:17:27.400 results quarter of their quotas and it's it's really not working. 0:17:28.000 --> 0:17:33.760 What we are saying is, don't abandoned fundamental analysis. You 0:17:33.880 --> 0:17:37.199 still have very good information out there. You're focusing on 0:17:37.320 --> 0:17:41.359 the wrong information, but you can shift and focus on 0:17:41.400 --> 0:17:46.240 the right information and you will be much better off. Okay, well, 0:17:46.240 --> 0:17:48.520 you know, before we wrap up, we have to talk 0:17:48.560 --> 0:17:52.000 about what these things are. So okay, you mentioned that, 0:17:52.119 --> 0:17:56.280 for example, it makes sense to not he too closely 0:17:56.400 --> 0:18:00.600 to traditional gap earnings. You also talked about the importance 0:18:00.640 --> 0:18:04.080 of having strategic assets. But for many companies that sounds 0:18:04.119 --> 0:18:07.040 like it would be something that you know, it's unquantitative 0:18:07.200 --> 0:18:10.880 or something fuel based. Let's talk what are the things 0:18:10.920 --> 0:18:13.800 in an earnings report, in anything else that we should 0:18:13.840 --> 0:18:17.399 really be focusing on instead to start building a mental 0:18:17.480 --> 0:18:20.400 model of what a company is worth. So I'll give 0:18:20.400 --> 0:18:23.920 you a couple of examples. If you're talking about pharmaceutical 0:18:23.960 --> 0:18:27.600 and biotech companies and you have a huge number of 0:18:27.640 --> 0:18:31.200 these companies, what they earned last quarter or last year, 0:18:31.280 --> 0:18:36.200 it's completely irrelevant to the future. What is relevant is 0:18:36.400 --> 0:18:41.879 what's called the product pipeline, the drugs, the instruments that 0:18:41.920 --> 0:18:47.119 they are developing. And all companies are providing very detailed 0:18:47.119 --> 0:18:50.080 information page of the page of the page. It's not 0:18:50.240 --> 0:18:53.879 required by accounting rules, but they are doing it on 0:18:54.000 --> 0:18:57.600 the product pipeline. So if the company has products in 0:18:57.680 --> 0:19:02.560 advanced stage of development, is two clinical tests, face three 0:19:02.600 --> 0:19:06.120 clinical tests, they are close to the market, high likelihood 0:19:06.119 --> 0:19:09.640 that new products will come out of them. This company 0:19:09.720 --> 0:19:12.760 is at a very good stage. I would invest in 0:19:12.800 --> 0:19:15.560 such a company. I don't care about the earnings of 0:19:15.560 --> 0:19:20.480 such a company. Talk about my second example, Internet companies, 0:19:20.520 --> 0:19:27.080 even insurance companies, media and entertainment. There's main strategic assets 0:19:27.160 --> 0:19:31.359 are customers. Look at the main data. Look at how 0:19:31.440 --> 0:19:35.199 many customers are being added every quarter. Look at the 0:19:35.359 --> 0:19:39.320 churn rate, which most people are not aware of. Churn 0:19:39.440 --> 0:19:43.879 rate meaning the center of customers they lose every quarter. 0:19:44.560 --> 0:19:49.200 That's what indicates the future, not the current earnings last 0:19:49.240 --> 0:19:55.480 earnings that they report. Basically, for every industry you have 0:19:55.720 --> 0:20:02.119 those fundamental strategic asset that create the you. For most companies, 0:20:02.440 --> 0:20:06.000 this information is given and the focus should be on 0:20:06.080 --> 0:20:10.320 the performance of these assets, the potential of these assets. 0:20:10.320 --> 0:20:13.000 Just just to play Devil's advocate, though, you talk about 0:20:13.119 --> 0:20:17.399 companies with drugs and stage two trials, But even then, 0:20:17.560 --> 0:20:20.880 to value that drug, don't you still have to come 0:20:20.960 --> 0:20:23.680 up with some model of how big the addressable market 0:20:23.760 --> 0:20:26.800 could be how much profit that drug is going to 0:20:26.880 --> 0:20:29.600 I mean, doesn't it still just come back to that 0:20:29.680 --> 0:20:31.919 being a tool to come up with some estimate of 0:20:32.240 --> 0:20:35.480 future earnings. Yes, you can do it and actually think 0:20:35.560 --> 0:20:38.879 and I developed such a model because they are they 0:20:38.920 --> 0:20:42.600 are quite reliable data on the likelihood of drugs in 0:20:42.720 --> 0:20:45.919 phase to get into the market, and then you have 0:20:46.119 --> 0:20:49.760 the market size for the drug. So ultimately you can 0:20:49.880 --> 0:20:54.840 come up with prediction of revenues from the drug. But 0:20:54.960 --> 0:20:58.359 the focus of analysis is not trying to predict just 0:20:58.520 --> 0:21:02.359 the revenues, but looking at the fundamentals what creates the 0:21:02.520 --> 0:21:07.800 value in all tasks. With this new mesthology, we actually 0:21:07.800 --> 0:21:11.840 have seen evidence showing that this different way of evaluating 0:21:12.040 --> 0:21:16.680 from suitable companies fundamental actually produces information signals that lead 0:21:17.200 --> 0:21:20.800 changing their market value. In other words, um, we can 0:21:20.840 --> 0:21:24.240 actually see the change in the value of their product 0:21:24.320 --> 0:21:30.720 pipeline before investors actually realize scenes are becoming different. Well, 0:21:30.840 --> 0:21:33.879 I'm sure we could talk about accounting all day, but 0:21:34.000 --> 0:21:36.280 we have to leave it there. That was baruque love 0:21:36.440 --> 0:21:39.040 and thank Goog, Thank you so much for joining us. 0:21:39.560 --> 0:21:53.159 Thank you, thank you so Joe, does that make you 0:21:53.200 --> 0:21:56.679 feel better or worse? About your previous career as a 0:21:56.720 --> 0:21:59.960 financial analyst. Well, you know, I'm no longer a finance 0:22:00.040 --> 0:22:01.920 chill analyst, So I guess it makes me feel good 0:22:01.960 --> 0:22:05.080 that I left that, you know, had I had. I 0:22:05.160 --> 0:22:09.520 just stuck to trying to estimate EPs and all that stuff. 0:22:09.920 --> 0:22:13.200 But uh no, in all seriousness, it is really interesting. 0:22:13.320 --> 0:22:15.919 I mean, one of the things I wonder is, like, 0:22:16.320 --> 0:22:20.840 to what extent do investors, you know, already sort of 0:22:20.920 --> 0:22:24.800 let these other factors determined I mean, the value of companies. 0:22:24.880 --> 0:22:28.320 It's not like all companies have the same PE ratio, 0:22:28.480 --> 0:22:32.160 the same port forward pe ratio. To some extent, it's 0:22:32.200 --> 0:22:36.000 pretty clear that things like network effects or an internal 0:22:36.040 --> 0:22:39.359 company culture that allows it to produce great drugs you 0:22:39.400 --> 0:22:42.720 would imagine, is already being reflected in a lot of 0:22:42.760 --> 0:22:45.720 people thinking about these companies, right, And you do have 0:22:45.760 --> 0:22:48.800 some pretty big companies out there that are highly valued 0:22:48.880 --> 0:22:55.320 that haven't necessarily had that successful um earnings quarters. I 0:22:55.400 --> 0:22:58.439 guess I think I think what it comes down to 0:22:58.520 --> 0:23:02.680 for me, I think our guests they've identified a problem 0:23:02.760 --> 0:23:06.359 which definitely exists. I think you can say the accounting rules, 0:23:06.720 --> 0:23:09.479 for sure, are not well equipped to deal with the 0:23:09.520 --> 0:23:14.160 realities of an economy that's increasingly about research and development 0:23:14.280 --> 0:23:18.560 and you know, brand value and information technology as opposed 0:23:18.600 --> 0:23:22.840 to um, you know, machinery and manufacturing. I'm not sure 0:23:23.440 --> 0:23:27.360 about the solution, because again, it's one thing to say, oh, 0:23:27.840 --> 0:23:31.919 investors should consider these strategic assets of a company, but 0:23:32.119 --> 0:23:34.359 at some point you do want to see those strategic 0:23:34.400 --> 0:23:38.560 assets converted into some sort of revenue, right, And that's 0:23:38.600 --> 0:23:41.320 sort of like, you know, it seems like a theory 0:23:41.359 --> 0:23:44.200 you should be able to square the circle and say, Okay, 0:23:44.320 --> 0:23:46.800 it's great to have these strategic assets, but you know, 0:23:46.840 --> 0:23:50.119 a strategic asset is only so good unless it produces 0:23:50.920 --> 0:23:54.520 revenue and income. But what I think is valuable here 0:23:54.560 --> 0:23:59.359 to me is like maybe we there's still it's like 0:23:59.400 --> 0:24:02.640 we have so many tuitive understanding that for all companies, 0:24:02.680 --> 0:24:05.560 whether it's an Amazon on one end, or whether it's 0:24:05.560 --> 0:24:09.040 a more standard industrial like a Honeywell or a g 0:24:09.200 --> 0:24:12.119 E on another end, that there's this whole spectrum of 0:24:12.160 --> 0:24:16.560 business models, and we sort of have this intuitive understanding 0:24:16.640 --> 0:24:19.199 that the sort of network effects or the customers are 0:24:19.200 --> 0:24:22.560 the attention of some companies matters a lot more for others. 0:24:22.560 --> 0:24:26.640 But maybe we still overrate the importance of a traditional 0:24:26.800 --> 0:24:31.359 earnings company for for traditional stock, even when it's not 0:24:31.440 --> 0:24:34.760 particularly appropriate, and that we have to sort of adjust 0:24:34.840 --> 0:24:38.360 our dial to recognize that it's not the same thing, 0:24:38.600 --> 0:24:40.760 looking at a sort of P n L statement for 0:24:40.800 --> 0:24:44.240 a traditional industrial versus a P and L statement for 0:24:44.640 --> 0:24:48.400 an Amazon or a Facebook. Yeah, I think that's right 0:24:48.640 --> 0:24:51.720 in any case. It's clearly a complicated topic, but something 0:24:51.840 --> 0:24:54.840 we can all keep in mind as earning season rolls on. 0:24:55.080 --> 0:24:57.359 And I'm very excited to read their book. I have 0:24:57.440 --> 0:25:00.439 it in front of me, The End of Account and 0:25:00.480 --> 0:25:03.560 the Path Forward for Investors and Managers by Baruke Lev 0:25:03.680 --> 0:25:07.600 and Fengu So thanks to them for joining us, and 0:25:07.920 --> 0:25:11.639 maybe we'll I'll read this and I'll get some more insight. 0:25:12.160 --> 0:25:15.399 All right, This has been another edition of the All 0:25:15.440 --> 0:25:18.320 Thoughts Podcast. I'm Tracy Alloway. You can follow me on 0:25:18.359 --> 0:25:21.399 Twitter at Tracy Alloway. And I'm Joe Wisenthal and you 0:25:21.440 --> 0:25:24.240 can follow me on Twitter at The Stalwart. And I 0:25:24.359 --> 0:25:28.080 want to thank our producer Sarah Patterson, who's on Twitter 0:25:28.200 --> 0:25:31.080 at Sarah patt With two Teas. Thanks for listening.