A Value Manager on How Most Value Managers Are Getting It All Wrong

Intrinsic Value

Rafe Resendes, co-founder of the Applied Finance Group, offers a fresh perspective on intrinsic value, challenging traditional valuation methods. He explains that intrinsic value is not merely about cheapness but involves assessing a company's economic profitability and its ability to reinvest profits effectively. Resendes emphasizes the importance of understanding the risk-adjusted returns and the economic profit horizon, which predicts how long a company can sustain profits above its cost of capital 1.

Intrinsic value is a function of this level of economic profitability, how much you're able to reinvest in the business to create more economic profits.

--- Rafe Resendes

This approach allows for a more accurate comparison of companies, moving beyond static models like the Gordon growth model 2.

   

Economic Profit

Resendes also critiques the traditional view that investment is inherently negative, arguing that it overlooks the wealth creation potential of reinvestment. He points out that companies like McDonald's and Apple have thrived by reinvesting profits, contradicting the notion that investment leads to underperformance 3.

Growth is bad, but it has to be tempered by what's the underlying wealth creation aspect of the company.

--- Rafe Resendes

By focusing on economic margins and management quality, Resendes believes investors can better identify companies that will generate positive returns, even in a factor-driven market.