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

Redefining Value

Rafe Resendes, co-founder of the Applied Finance Group, challenges the traditional metrics of value investing, such as the book-to-price ratio, which he argues have been misused as mere indicators of cheapness rather than true value. He emphasizes the importance of understanding intrinsic value through comprehensive valuation approaches, which his firm has specialized in since 1995 1. Resendes notes that while historical data might suggest certain metrics were once effective, they often fail in live settings, highlighting the need for a shift in focus from cheapness to intrinsic value 2.

The term value has really been hijacked, because book to price, at the end of the day, is really nothing more than a cheapness metric.

--- Rafe Resendes

This approach aims to provide a more accurate reflection of a company's worth across various market environments.

   

Intangible Challenges

Resendes explores the complexities of intangible assets, which traditional valuation metrics often overlook. He criticizes the simplistic approach of treating intangibles as mere valuation issues, arguing instead for a performance-based assessment 3. By focusing on how well a company utilizes its intangible investments, Resendes believes a more accurate picture of its economic performance can be drawn.

Companies that consistently are generating significantly positive returns on that investment will start to see their ROIs increase as they continue spending.

--- Rafe Resendes

This perspective challenges conventional accounting practices and calls for a reevaluation of how intangibles are factored into a company's valuation 2.

   

Beyond Cheapness

The conversation shifts to why traditional measures of cheapness, like price-to-book ratios, no longer yield the returns they once did. Resendes argues that these metrics fail to capture a company's true intrinsic value, advocating for a more nuanced approach that considers economic margins and capital structure 4. This rethinking of value investing aims to redefine what constitutes a valuable investment, moving beyond outdated metrics.

If you have a negative spread to your cost of capital, you should be shrinking your business or rationalizing what you have.

--- Rafe Resendes

By focusing on intrinsic value rather than cheapness, investors can better identify companies that are truly worth investing in 5.