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The New Strategic Deal in Value Investing
European Straits #112
If everything has gone well, I just arrived in Singapore 🇸🇬. I’m here to take part in a 2-day conference organized by the French Cercle des économistes with the Economic Society of Singapore at the Lee Kuan Yew School of Public Affairs. You can find more by following this link. My part will be to participate in a panel on “Disruption, Fintech, and Innovation: Who Will Be the New Winners?” on Friday morning.
My view of Singapore before travelling was “one of the two business centers in Southeast Asia” (with Hong Kong). I know that many multinationals have their Asian headquarters there, and that INSEAD has located one of its two sites in Singapore (the other being Fontainebleau). I know that the nation’s founding father was a statesman named Lee Kuan Yew, who passed away in 2015 and was unanimously respected—most notably by Henry Kissinger. And I’ve seen Crazy Rich Asians 😜.
All of these were enough to make me want to know more. I’ve been reading a lot about Singapore recently, notably following recommendations by readers of this newsletter. And thank you 🤗! I even know the topics I’d like to cover in next week’s issue: I’ll write about Lee Kuan Yew, Singapore’s housing policy, the languages people speak here, and cryptocurrencies. If you’re intrigued, stay tuned 😉
One more thing: I’ve been invited by Thomas Jestin and French Tech Singapore to speak about startups in Europe, my book Hedge, and The Family. The event will take place on Monday, March 18, at 6:30pm. You can register on Eventbrite by following this link: Nicolas Colin [The Family] x French Tech SG.
Value investing in the Entrepreneurial Age
I discovered value investing fairly recently. Like many people, I had a superficial knowledge of Warren Buffett: the mysterious Oracle of Omaha, a genius stock picker, one of the most successful investors in the world, and one of Barack Obama’s most prominent economic advisors. But I didn’t really get that his practice was called “value investing”, defined as “an investment tactic where stocks are selected which appear to trade for less than their intrinsic, or book, values”.
My true discovery of Warren Buffett was when my cofounder Oussama Ammar told me, sometime in 2013, that he had found the right comparison for what we were building at The Family, and it was Buffett's Berkshire Hathaway. “You should read the book about Buffett, The Snowball.” So I bought the book and read it. Then two years later we decided to write about the comparison, so I also bought Benjamin Graham’s foundational The Intelligent Investor. And then I read many, many more articles about Warren Buffett, Buffett's partner Charlie Munger, Berkshire Hathaway, and value investing in general. And then Oussama and I ended up co-writing our longest piece ever: The Berkshire Hathaway You Haven’t Noticed (Yet).
As you know, writing (or teaching) is the best way to learn, and so that effort put me on track to reflecting more on value investing. Oussama and I developed the idea that early stage venture investing was the equivalent of value investing in the Entrepreneurial Age, and that The Family was the right infrastructure to put it into practice. But I also became obsessed with yet another idea: How can we reinvent value investing for mature stocks in the Entrepreneurial Age? Because this new age is a challenge for value investors: assets have moved off the balance sheet and are more difficult to assess; competition is so fierce that new empires can be built in a matter of years while others falter; and businesses are protected from challengers not by traditional barriers to entry, but by their fast growth.
For a time, the answer has been that you cannot practice the art of value investing with technology stocks. According to Buffett, a good value investor does not like to own stocks in companies whose business they do not understand. And technology is difficult to understand for investors who are used to steady businesses in industries such as insurance, utilities, and consumer brands.
But I had my own idea. In my view, the best way to explain what the digital economy is about is the following: There is now more power outside than inside organizations. Consequently, the companies that win are those who are best organized to harness that power from the outside—one that is vested in the multitude of networked individuals. And it should be possible to assess the intrinsic value of a business based on its capacity to harness the power of the multitude—an intrinsic value that is in fact extrinsic 🤔! Can a new generation of value investors learn to detect that certain companies are better equipped than others for long-term competition in the Entrepreneurial Age?
For a long time I struggled with this idea. I tried to come up with mathematical modeling, learning from seasoned financier Nicolas de Mascarel, and spent time sparring with my friend and financial modeling expert Jérôme Cachau. But it’s really the following five things that made me realize that there’s something to be pursued here—a radical reinvention of value investing in a world where value lies outside the organization rather than on a company’s books:
While writing In Search of Scalability, a paper about strategy in the age of increasing returns to scale, I discovered the work of legendary investment strategist Michael Mauboussin. In works such as Measuring the Moat, Exploring Network Economics, and Capital Allocation, you can tell that Mauboussin is circling around the idea that you can assess the intrinsic value in tech-driven businesses.
In illuminating Talks at Google, various value investors have been giving explanations of why, after years of reluctance, tech companies have become acceptable for them. You can watch Oakmark’s Bill Nygren here and Whitney Tilson here. Hint: it’s all about the network effects that make thriving tech companies virtually immune to competitive challenges.
In Barron’s, Abhay Deshpande pointed out that “[Some value investors] have not recognized how the value of corporations—like franchise value and brands—has shifted off-balance sheet, and then have made the additional error of not seeing how the margin of safety has changed. The margin of safety was just price-based before, but now you have to be careful that there is no Amazon threat, for example, or that you are not stuck in dying retail channels”. Indeed startups rising should be accounted for in assessing the intrinsic value of an established business.
What nailed the whole thing is a recent article shared with me by my friend and business partner Gregory Edberg. It’s by Adam Seessel, a former journalist turned value investor. And here’s what he writes: “Now the top four companies in the world by market capitalization are all “tech”—Apple, Amazon, Microsoft, and Alphabet—but not in the same way that semiconductors and integrated circuits are tech. These businesses, in fact, have much more in common with the durable, dominant consumer franchises of the postwar period. Their products and services are woven into the everyday fabric of the lives of billions of people. Thanks to daily usage and good, old-fashioned human habit, this interweaving will only deepen with the passage of time”.
Additionally, might I simply point out that many people are working at developing new tools to assess the capacities of certain companies to harness the power of their networked users. You should have a look at the great work that a16z’s Andrew Chen has done on growth over the years. And you can also explore the incredible toolbox developed by James Currier’s NFX around the measurement and assessment of network effects as a distinctive feature of tech companies.
I’m not sure I can elaborate much more here beyond sharing some links (see below). Let it be said that I’ve started my thought process, and that I might come up with more ideas, and maybe even models, on how value investing could be reinvented for the Entrepreneurial Age. I’ll keep you in the loop!
More book reviews + podcast
📚 Here are five more book reviews that I previously published in Le Monde (English translations):
On The New Geography of Jobs by Enrico Moretti: The New Geography of Jobs
On Radical Help by Hilary Cottam: The Networked Welfare State
On A Grammar of the Multitude by Paolo Virno: Democracy Tested by the Multitude
On Sleeping Giant by Tamara Draut: The Workers Are No Longer in Factories
On The Revolt of the Public by Martin Gurri: The Internet, Land of Perpetual Anger
🎙️ Also, when I was in New York I recorded a podcast with Colin Mortimer of the Neoliberal Project. Bear in mind that “neoliberalism” in this case means reinventing liberalism in the US sense of the term, not singing songs about Friedrich Hayek and Milton Friedman. The podcast is available exclusively for those who support the Neoliberal Project through Patreon, but I’d say it’s a good cause. Here’s the link: Entrepreneurial Liberalism ft. Nicolas Colin.
Further readings on the future of value investing
The Art of Value Investing (video—John Heins & Whitney Tilson, Talks at Google, December 2014)
Should VCs invest like Charlie Munger? (Index Ventures’s Martin Mignot, Medium, December 2015)
The New Berkshire Hathaway You Haven’t Noticed (Yet) (my cofounder Oussama Ammar and me, The Family Papers, July 2016)
In Search of Scalability (me, The Family Papers, August 2016)
Measuring the Moat: Assessing the Magnitude and Sustainability of Value Creation (Michael Mauboussin, Credit Suisse, November 2016)
(me, my weekly newsletter, September 2017)
Value Investing Principles and Approach (video—Bill Nygren, Talks at Google, December 2017)
Why Financial Statements Don’t Work for Digital Companies (Vijay Govindarajan, Shivaram Rajgopal, Anup Srivastava, Harvard Business Review, February 2018)
Network-Based Businesses Will Disrupt All Sectors of the Economy (Mike Maples, Fortune, August 2018)
An Evolve-or-Die Moment for the World's Great Investors (Adam Seessel, Fortune, November 2018)
This Global Money Manager Sat on Cash and Gold for 2 Years. Now He’s Snapping Up Stocks. (Reshma Kapadia, Barron’s, February 2019)
Warm regards (from Singapore),