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

Episode Summary

Executive Summary: The episode argues that “value investing” has been muddled by cheapness metrics like price-to-book, which miss intrinsic value in an economy rich in intangibles. Guest Rafael Resendez explains Applied Finance’s long-running valuation framework, built from live out-of-sample data, that incorporates capitalized R&D, leases, inflation, leverage, and an economic profit horizon to estimate true intrinsic value. He contends this framework better explains winners like Monster, Nvidia, Apple, and Google than traditional factor models.

Main Topics: Value investing vs. cheapness (Priority: 5/5): The hosts and guest distinguish true valuation from simple ratio-based cheapness screens, arguing that book-to-price is a cheapness metric, not a measure of worth. Applied Finance’s intrinsic value framework (Priority: 5/5): Resendez outlines a valuation method that reconstructs financial statements, capitalizes R&D and leases, adjusts for inflation and capital structure, and estimates intrinsic value via economic margin and economic profit horizon. Backtests vs. live evidence (Priority: 5/5): A major critique is that many factor strategies look good in historical backtests but fail live; Resendez emphasizes 22 years of out-of-sample, real-time evidence instead. Intangibles and modern corporate value (Priority: 4/5): The discussion centers on how software, brand, R&D, and network effects create value that traditional accounting and book value miss, especially in tech and platform companies. Correlation, causality, and factor investing (Priority: 5/5): Resendez argues that book-to-price and related factors often work only when they are correlated with underlying intrinsic value, not because the factor itself is causal. Portfolio examples: Monster, Nvidia, Apple, Google, Facebook (Priority: 4/5): Concrete examples illustrate how the framework identified durable compounders years before their largest price moves and maintained positions until valuation became less attractive. Interest rates, duration, and market regime (Priority: 3/5): The guest links growth vs. value performance to discount rates and duration, suggesting lower rates favor long-duration growth stocks while rising rates could help traditional value.

Key Arguments: Traditional value metrics like price-to-book are cheapness measures, not true valuation measures, and can mislead investors about intrinsic worth. A proper valuation framework should start with intrinsic value and then compare price to that estimate, rather than starting with a ratio and calling it value. Accounting conservatism understates investment in intangibles; capitalizing R&D and leases provides a more accurate picture of economic returns. Backtested factors often degrade once they go live; robust investing research requires live out-of-sample evidence over many years. Book-to-price appears to work mainly when it overlaps with intrinsically undervalued companies; isolated cheapness signals can generate negative alpha. Companies with positive economic margins should be encouraged to grow, while firms with negative economic margins are wealth destroyers and should shrink or restructure. The value vs. growth divide is overstated; every company has growth, and what matters is the price paid relative to economic profitability, reinvestment, risk, and competition. Many so-called investment factors miss the point because they penalize companies for reinvesting without accounting for the returns on that reinvestment. Rising discount rates would likely hurt long-duration growth stocks and potentially revive more traditional value names, but the key is how the market prices that change. Passive and factor strategies can be exploited if they systematically overbuy overvalued names and underbuy undervalued ones.

Data Points: Stock Movers report length: 5 minutes or less - Promo describing Bloomberg’s short audio stock report format. Applied Finance founding year: 1995 - Resendez says the firm has specialized in valuation since 1995. Observation window before live estimates: 25 years - He describes research from the 1970s to 1995 as the period used to build the framework. First intrinsic value estimates: 1996 - The firm began calculating intrinsic value estimates for U.S. companies after its observation phase. Monthly global intrinsic value coverage: 20,000 companies every week - Resendez says the firm now calculates valuations globally at this scale. Book-to-price era of strong performance: 1963 to 1991 - He says book-to-price was a money-making machine before 1992. Book-to-price live period discussed: 1998 to 2020 - He says their live data show no alpha from book-to-price in that period. Portfolio turnover: less than 10% a year - Resendez says the main strategy is low turnover. Nvidia purchase price: $13 a share - He cites buying Nvidia in 2011 at this price. Nvidia sale price: $520 - He says they sold Nvidia in August after it exceeded intrinsic value. Nvidia drawdown cited: from 300 to 150 - He recalls the 2018 decline that led outsiders to think the fund was wrong. Monster return on capital: 10% to 15% above cost of capital - Used to illustrate Monster as a wealth compounding company. Portfolio mix by 2014: approximately 25 stocks value/core and 25 stocks core/growth - Resendez describes how the portfolio composition evolved over time. Portfolio mix by August 2020: about 70% to 75% value/core - He says the portfolio had shifted more toward value as growth valuations rose. Expected Cisco growth implied in 2000 call: 50%+ sales growth for five years - Example of their value expectations framework used in a market call. Current rate environment: zero - Resendez references rates at zero when discussing duration and discount rates.

Pivotal Quotes: "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." — Rafael Resendez: Explaining why he rejects the conventional use of value investing terminology. "Book to price since 98 has added zero to the investing world." — Rafael Resendez: Arguing that cheapness alone does not generate alpha unless supported by intrinsic value. "You can have value stocks that represent an incredible investment opportunity just as easily as you can have a stock like Monster represent an incredible investment opportunity." — Rafael Resendez: Summarizing his view that true value is independent of classic growth/value labels.

Implications: Investors should question ratio-based “value” screens and focus on economics, reinvestment quality, and live evidence. For quant and factor investing, the episode suggests many signals may be artifacts of overlapping true valuation rather than standalone sources of alpha.