Value investing, or choosing stocks believed to be trading at less than their intrinsic value, is often considered a tried-and-true strategy. But the environment has changed drastically in the past few years; tech behemoths dominate the market, global interconnection continues to increase, and policy changes have become ever more difficult to anticipate.
The foundational principles of value investing are as relevant today as when Benjamin Graham and David Dodd published their seminal Security Analysis. However, today's market presents unique challenges and exciting opportunities for the value investor. To succeed, we believe it’s necessary to look beyond traditional metrics and embrace a broader definition of what makes a company valuable.
Let’s look at how we can adapt a value investing strategy for today's market, with a focus on valuing intangible assets and exploring global opportunities.
Beyond book value: technology and intangible assets
Traditionally, a company's value has been tied to its physical assets: factories, machinery, and inventory. Value investors could analyze a balance sheet, calculate a company's book value (total assets – total liabilities), and look at the price-to book ratio to identify companies they thought were trading on the cheap.1
Today however, many of the global market’s premier companies have few physical assets. Their value comes from intangible assets such as software, brand recognition, intellectual property, and network effects.
Companies like Google, Meta, and Microsoft* don't own massive factories with significant capital equipment. Their measurement of value comes from code, user data, and the ecosystems they've built.
Relying on traditional metrics like the price-to-book (P/B) ratio can be misleading for these businesses, as it excludes intangible assets. Consequently, they can appear overvalued on a price-to-book basis when in fact they could be outstanding long-term investments.
Valuation metrics for today’s companies
To find value in a tech-driven market, you have to expand the analytical toolkit. Instead of looking at book value, consider metrics that measure the strength of a company's intangible assets:
- Average revenue per user (ARPU)2: This metric is critical for social media, software-as-a-service (SaaS), and other platform-based companies. For the period you're analyzing, divide total revenue by the average number of users. A rising RPU indicates that a company is improving its ability to monetize its user base.
Since the number of subscribers obviously impacts revenue, this metric is a critical input for revenue forecasting.
- Customer acquisition cost (CAC)3: This ratio represents the average total spend to acquire a new customer. To calculate for a specified period, divide total sales and marketing costs (typically advertising, sales and marketing salaries, marketing-related technology, etc.) by the number of new customers for the period. This metric is critical for evaluating profitability and the marketing return on investment (ROI).
- Lifetime value (LTV)4: This is the total predicted revenue a business expects to generate throughout their relationship with a customer. How it’s calculated depends on the type of business. As an example, let’s use a subscription business with an average monthly price of $500. Divide this cost by the churn rate, which is the percentage of the customer base lost per month. Say it’s 5%. 500/.05 gives us an LTV of $10,000.
Now, divide the LTV by the CAC. A healthy business should have an LTV that is significantly higher than the CAC. A ratio of 3:1 or better is considered desirable. A company that can acquire customers inexpensively and retain them for a long time has a powerful competitive advantage.
- Market Share: In many tech sectors, markets are "winner-take-all" or "winner-take-most." The company with the dominant market share benefits from network effects, where the product becomes more valuable as more people use it. This creates a formidable barrier to entry for competitors.
By looking at these metrics, you can get a clearer picture of a company's true intrinsic value, even if its P/B ratio seems high. The goal remains the same—finding a disconnect between price and value—but the method of finding that value has changed.
Unlocking global opportunities
Investors who limit themselves to the domestic market are overlooking a world of potential opportunities. While the U.S. is home to many of the world’s leading companies, compelling valuations can often be found in international and emerging markets. These markets are frequently less efficient than the U.S. market, meaning there could be a greater chance of finding hidden gems.
Emerging markets, in particular, can offer exposure to rapidly growing economies and burgeoning middle classes. As incomes rise in these countries, often too does consumer spending, creating a powerful tailwind for emerging markets companies. However, investing globally comes with its own set of challenges.
Navigating international markets
Before investing in a foreign company, it’s even more vital to do rigorous research. Here are some key factors to consider:
- Political and economic risk: Political instability and economic downturns can have a significant impact on an investment. Particularly in emerging markets, there can be greater instability. Take a top-down approach and research the political climate and economic stability of the country where the company is based.
- Currency fluctuations: When you invest internationally, returns are affected by changes in currency exchange rates. A strong dollar can reduce the returns from your foreign investments, while a weak dollar can result in currency gains.
- Differing accounting standards: Companies in different countries use different accounting standards, which can make it difficult to compare financial statements. You may need to adjust certain line items in the financial statements to make accurate comparisons among companies domiciled in different companies.
Despite these hurdles, the potential rewards from global investing could be significant. By carefully researching and diversifying your holdings, it’s possible to find attractive value investments in many different markets.
The takeaway
The world is constantly changing, and the stock market is no exception. While the tools you use in value investing have to adapt, we believe the core principles are timeless. The goal has always been and will always be to buy a business for less than it is truly worth.
By expanding the definition of value to include intangible assets, and by broadening your horizons to include global markets, you can continue to apply the powerful logic of value investing in today's environment.
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