Portfolio Enhancements Articles
If you would like to more deeply understand the enhancements to our investment strategy, we encourage you to review the following articles written by our new partners and the academic community. In addition, our Investment Team is happy to discuss this content in more detail.
“Over the past several decades, companies in the developed world have shifted their investment spending from physical assets like manufacturing plants to more intangible ones like software, branding, customer networks, etc.”
“Accounting practices that were developed for an industrial economy have struggled with this economic evolution and the transparency and comparability of financial reporting has suffered significantly as a result.”
– Distillate Capital, Value Investing in a Capital-Light World
“The four largest companies today by market value do not need any net tangible assets. They are not like AT&T, GM, or Exxon Mobil, requiring lots of capital to produce earnings. We have become an asset-light economy.”
– Warren Buffett, 2018 Shareholder Meeting
“For nearly three decades, the initial paragraph featured the percentage change in Berkshire’s per-share book value. It’s now time to abandon that practice. The fact is that the annual change in Berkshire’s book value … is a metric that has lost the relevance it once had.”
– Warren Buffett, 2018 Investor Shareholder Letter
“It stands to reason that the signal from statistical factors would weaken if intangible investments distort earnings and book value. This development is not lost on quantitative investors. There is a good argument to be made that the ineffectiveness of the value factor is in part because of its diminished ability to reflect economic reality.”
-Michael Mauboussin, One Job
“The shift in investments from tangible to intangible assets has important implications for how investors should think about corporate growth rates. Intangible assets have greater potential economies of scale and higher risk of obsolescence than tangible assets. This means companies with more intangible assets can grow faster, but they can also become irrelevant and shrink faster.”
-Michael Mauboussin, The Impact of Intangibles on Base Rates
“The continued growth of intangible investments is the hallmark of developed economies, initiating significant changes in the business models, strategies and performance of business enterprises. Accounting standard‐setters, however, by and large, are oblivious to this world‐wide development. I establish in this study that this accounting resistance to change seriously harms investors.”
– Baruch Lev, Intangibles
“There are obvious problems in comparing businesses which rely on tangible assets with those that rely mostly on intangibles.”
– Terry Smith, 2020 Fundsmith Annual Shareholder Letter
“We study the use of firms’ book-to-market ratios (B/M) in value investing and its implications for comovements in firms’ stock returns and trading volumes. We show B/M has become increasingly detached from common alternative valuation ratios over time while also becoming worse at forecasting future returns and growth in both an absolute and relative sense.”
“A shift in the economy toward firms investing in knowledge and organizational capital and increasing shareholder payouts contribute to these trends.”
– Choi, So and Wang, Going by the Book: Valuation Ratios and Stock Returns
“We document an upward trend on investor responsiveness to free cash flow … we find that the market response is especially strong for newer firms with high levels of intangible assets.”
– Adame, Koski and McVay, Why Are Investors Paying More Attention to Free Cash Flows?
“The shift in economic activity from industry/manufacturing to services has increased the importance of intangible capital—customers, trained employees, product portfolios, receivable, property, plant and equipment that accountants have traditionally included on a business’s balance sheet. Moreover, since investments in intangibles—advertising, hiring, training, and product development—are often counted as current expenses for accounting purposes, defining and measuring current earnings power has become more difficult. Technological developments have had a similar impact. Modern computer and Internet-based firms like Amazon, Google, Oracle, Facebook, Microsoft, and Netflix have relatively little physical capital. Much of their growth related investments are, for accounting purposes, buried in expenses, where they depress, perhaps excessively, reported earnings and raise some valuation multiples.”
– Bruce Greenwald, Value Investing – From Graham to Buffett and Beyond
“The below chart shows how a portfolio built on each of these metrics performed since December 31, 1991. Free cash flow yield (free cash flow/enterprise value) offered the investor the highest return and the fewest periods of negative returns. Going forward, there is no way to be sure that free cash flow yield will continue to provide the best returns. In fact, there have been market cycles where companies with high free cash flow yields have underperformed. Nevertheless, we believe there is a compelling reason to invest using free cash flow yield.”
– Pacer Financial, The Power of Free Cash Flow Yield
“The top-quintile stocks by free cash flow yield generated an annualized return of 15.7% from December 1990 to June 2017, exceeding the rest of the quintiles and outperforming the overall market by an average of 3.6%.”
– S&P Global Research, Incorporating Free Cash Flow Yield in Dividend Analysis