I recently had the pleasure of watching Bruce Greenwald’s presentation from the Welcome Event for the 12th International Post Keynesian Conference. Thanks to Tobias Carlisle for pointing me to the presentation. More details on the conference are available at pkconference.com.
In the presentation, Greenwald outlines a method for investing that holds true for private and public companies. The basic principle of investing in sustainable earnings that can feed growth above the cost of capital is an incredibly simple one. Usually the biggest difference between early stage private startups and their more mature public companies are the assets and liquidation value. Most startups have virtually no value on liquidation (especially now that they all use cloud computing instead of buying servers). Most more mature companies of course do have a liquidating value that provides a safety net or base value that can be calculated. Once you get above the value of the assets though everything else is the same and what you are investing in is essentially the same thing.
I’ve recently been more and more involved with Gil Penchina’s AngelList syndicate (Invest alongside us at AngelList) and many of the metrics that we use to evaluate opportunities boil down to how much money is on the table every month that can be reinvested in the business at a rate of return above the cost of capital. If there is a lot, the value of the business is higher and if there is none, the value of the business is questionable (which would be the same conclusion Greenwald would come to if a business had no assets).
I’ve seen others try to use Michael Porter’s five forces to analyze startups and public companies and I have always had a hard time understanding how to properly value and assess the businesses based on the five forces. Greenwald gently tears apart Michael Porter’s five forces (More on Porter’s views on strategy in his book Competitive Advantage: Creating and Sustaining Superior Performance) of course Greenwald has a competing book (Competition Demystified: A Radically Simplified Approach to Business Strategy) out which I definitely think is more comprehensive and in my opinion more straight forward
Here are some of the great quotes from Greenwald in the lecture…
“The problem with Porter’s 5 forces is that it’s 4 forces too many” –Greenwald
“Porter’s strategies have nothing to do with his forces” -Greenwald
“The problem with DCF is that you are guessing on terminal value” –Greenwald
“Commodity businesses are bad businesses” –Greenwald
“It is a lot more fun to buy a kitten then to drown it later” –Greenwald
“Once you put something in the market, you tend to leave it there for a long time” –Greenwald
“Good businesses think small and think locally either in product space or in geography” –Greenwald
Here’s the basic math that you need to be using that Greenwald outlines in his lecture…
- divide sustainable earnings by the price
- How much of those earnings are they paying you in cash (dividends or stock buyback)
- Where are they investing the other portion? Are they beating the cost of capital with that money?
- The higher the total return percentage (percentage of cash return you’re receiving per share and percentage return above the cost of capital for reinvested dollars), the higher the value of the business.
If you want more after watching the lecture, check out Bruce’s book on value investing Value Investing: From Graham to Buffett and Beyond (Wiley Finance)