Moneyball Series Part 4 — Adapt or Die — The Moss Piglet

Moneyball is somewhat similar to value investing where we buy assets with high earnings power or value for the least amount of money possible. I decided to start this series to look at some of the timeless lessons from Moneyball that are applicable to investing. I hope that you would have as much fun reading this series as much as I had writing them.

https://youtu.be/vQbUZZVv4Rg

The above was one of my favourite scenes. Adapt or die.

Billy Beane (Brad Pitt), general manager of the Oakland Athletics Major League Baseball team, had his work cut out for him. Faced with a tight budget, Beane had to reinvent his team strong enough to make a run in the playoffs. He challenged old-school traditions in order to outsmart the richer clubs. So that his team could survive and he could keep his job.

The solution Beane ultimately adopted involved an unorthodox, scientific approach. He engaged a statistician to identify bargain-bin players with game-winning potential but whom the scouts had labeled as flawed.

And therein lies the truth and moral of our story. In times of unprecedented challenges:

“We’ve got to think differently.” We’ve got to “adapt or die.”

Value Investing Falling Out of Favour

As stock prices continue their climb, value investing has fallen out of favour. This approach has performed poorly since the 2008 Financial Crisis.

The foundation of value investing is to look for good deals and good fundamentals before investing. From the looks of it, these principles cannot be bad for your portfolio. What would be the opposite? follow the hype train? That is how bubbles are created.

Still, value investing under-performed because of a series of reasons.

1. Indeed some of the growth companies indeed did become monopolies. Many of these companies had the valuation inflated by the concept that “the winner takes it all”. In same cases it was actually like that because of the economy of network on which these companies rely on. Hence it is normal that they did over-perform the rest of the market.
2. COVID19 accelerating a transition already in act from the “analogical” world to the digital era. Even grandparents suddenly have started using video conferences and online shopping. My mum has started using RedMart and Fairprice Online to purchase groceries. This altered the expected behavior for which higher beta stock. They performed well during growth period and ended up performing better even in the crisis.
3. ETFs have reached such a massive size that in some instances are likely to alter the market
4. The market works a lot following self-fulfilling prophecies. In the past, everyone followed Buffet’s stock picks which further helped his own results. Currently, the prophecy is that growth companies like Crowdstrike and Fastly (Seriously I still don’t understand what’s the hype for Fastly) will continue to grow strong due to their potential “monopoly”.
5. The market has some obvious distortions, which are clearly fueled by hype which will hold only temporarily. Just look at the stock movements of Tesla or Zoom. This latter has an incredible valuation compared to competitors that are offering the same solution (eg. BYD is the first EV maker that is selling in China, but no (or less) hype.).

You’re Not A Value Investor If You’re Just Looking At The Numbers

I love looking through numbers and numbers like high PE ratio, P/FCF turns me off.

However, the bifurcation of value investing versus growth or other labels to investing is a bit artificial; they are both looking for stocks that they believe the market has incorrectly priced. In short, everyone is still looking for a bargain.

I learnt that if you want to get a different result, you’re going to have to use a different approach. Be conventional and enjoy an illusion of safety, or pursue an unconventional approach with better chance of success but more risk. Just like what Beane did in Moneyball.

Here’s my take on why value investing based on the traditional numbers didn’t work too well:

1. Companies value investors like are usually mature companies with their growth phase behind them thus they are making little new investments and CAPEX usually< depreciation, ex acquisitions. That also explains why these companies have higher free cash flow.
2. Growth companies are making lots of investments. It is the assessment of these by an investor vs. the market that an investor is assessing in hope that the market is underestimating the opportunity.
3. Value Myopia. That’s when you don’t have the foresight or business acumen to accurately quantify the revenue stream of a digital business. Don’t blame the numbers. Like the railroad and oil revolutions before it, the digital revolution is starting to take off and will also eventually run its course.
4. Interest rates have affected returns. In a low interest rate environment, the cash flows of mature, traditional value investor attractive companies are not worth all that much contrasted with prospective cash flows of growing companies.
5. In high interest rate environment, mature companies with free cash flow is worth more than the high growth company which usually has none. Thus, investors will prefer growth companies in a low interest rate environment.
6. In a low interest rate world, growth will likely to outperform much to the chagrin of the value crowd.

Value Investing 3.0

I consider Warren Buffett’s value investing approach as Value Investing 2.0 since Charlie Munger joined him. They have never been pure Benjamin Graham fundamentalists ( Ben Graham the OG, Version 1.0). Their value investing principle is from a pure management perspective. Their strength as investors is the use of their liquidity, deploying and allocating capital very efficiently at scale. Then, they let efficient CEOs like Jack Welch and managers run the show.

The future of value investing? I feel that version 3.0 has already been cooked by entrepreneurs like Jeff Bezos and Pony Ma. Their business is like the Berkshire Hathaway of the 21st century. Amazon and Tencent are now conglomerates that efficiently deploys capital at scale under the watch of efficient managers with incentives aligned for good management practices.

Final Thoughts

To me, all investing is value investing. The rest are split between opportunistic gamblers and speculators.

However, ‘Value’ is subjective as it takes a number of factors for a company to succeed generally. In a more rapidly changing world, your strategy also becomes more difficult to pin down for the long term.

At heart being a value investor, you must have the stomach for pain, ability to hold positions when they are bleeding and traders gloating over their winning trades (from what they share on social media, seems like they are getting 100% of their trades right. If you know what I mean). Good value investors are headstrong, smart and stubborn, possibly emotionally stunted in some ways.

We must update our approach for a changing world. For me, it is to widen my circle of competence (But seriously can someone explain Fastly to me like a 5 year old?). As mentioned above, Mr. Buffett changed his approach from a buyer of cigar-but companies (companies trading below book value) to a buyer of franchises after he met Charlie. For Value investing 3.0, we could be looking at capital allocators like Pony Ma (Tencent), Zhang Yiming (Bytedance) etc.

If there is one conversation worth following in the next decade, it would be one about how value investing will adapt, not die.

Cheers.

Originally published at https://themosspiglets.com on October 24, 2020.