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A New Theory of Value Investing, Amidst the Downturn
A Historical Framework
The Pendulum is Swinging Back
Progress consists of taking two steps forward and one step back. Humanity has been oscillating between times of optimism and pessimism since as far back as we can see. In the past few years, there has been plenty of optimism, with much money chasing conceptually promising securities, with arguably feeble financials.
This has no doubt been aided by decreasing rates and thus higher levels of liquidity. Crypto has flourished and so has biotech, amongst other more sure footed yet enthusiasm-packed verticals.
What they all have in common is very promising technologies and potential future developments, coupled with great enthusiasm and a financial situation that is yet to be made sense of. This is a common theme throughout history.
Today, we take trains for granted. By 1873, however, much money had been invested in American railway infrastructure, whilst the technology was not quite ready to yield profitable enterprises yet. The main speculation of the day was that the development of the US west coast would eventually make railways profitable.
During that year, unfortunately, many railway companies began to default. This eventually led to a liquidity crisis, which culminated into a decade long economic depression.
The technology underlying today´s trains is not radically different to the technology that contemporaries of that time marveled at, yet railways have arguably taken 100 years since to be instantiated as persistent and economically sustainable components of our transport system. Warren Buffett only bought Burlington Northern Santa Fe in 2009.
I do not argue by any means that we are heading into a depression, but rather that the analogy for trains applies to a number of technologies that have received much attention in the last few years, notably crypto and biotech.
They will both change the world for the better, but it looks like the levels of enthusiasm are largely disconnected from and way above their current ability to drive economic progress. Whilst I am not making a prediction, I do assign a high probability of continued pain in both spaces.
The above framework can be extrapolated to other frothy areas of the market, perhaps to a lesser degree. I do not believe the above to be the case so much due to likely less liquidity in the system going forward due to higher rates, but rather to the pendulum swinging back, as it has done through history.
Value Will Prevail
I have been thinking about this for some time now and will likely write about it in more detail in the near future, but I believe that a new theory of value is now befitting. It may turn out to be quite succesful at predicting which stocks will do well out of the whole innovative bunch.
As we make our way into the digital economy, enterprise value is less and less explained for by book value. This is because intangibles drive an increasing chunk of our economic activity and we cannot account for them. Simultaneously, digital technologies have made arbitrage situations of the obvious kind easier to spot and hence less prevalent.
As such, the core of value investing is no longer about finding pessimistically underpriced collections of productive physical assets, but rather about being able to tell when a collection of (likely) unrelated intangible assets is able to drive real economic returns, when the market is simultaneously disregarding it. I believe examples of this to be $SPOT, $BB, $GPRO and $AMRS.
I say unrelated, because productivity in the intangible space is very often about bringing together unrelated ideas to form a new productive layer of the noosphere. This takes time and in the early phases, it often makes for meek looking businesses. Nonetheless, intangibles compound fairly quickly as we have seen in stocks such as $TSLA.
I believe being able to discern in this new frontier is the main challenge of our times as investors. More thoughts coming soon.
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