Key Takeaways
1. Value Investing Must Adapt to the Digital Age
To continue as I had would have been to ignore economic reality and to consign myself and my clients to a future of dismal performance.
The world has changed. Traditional value investing principles, focused on asset values and reversion to the mean, are failing to capture the wealth created by digital companies. The rise of tech has been so rapid and transformative that old metrics no longer accurately reflect the value and potential of these businesses.
Tech's dominance. A significant portion of the U.S. market's gains in recent years has come from the information technology sector. Digital companies are creating most of the incremental wealth in the world today, while simultaneously hollowing out large parts of the legacy economy. Examples:
- The fossil fuel sector has shrunk dramatically as a percentage of the U.S. stock market's value.
- Amazon is now significantly more valuable than traditional blue-chip companies like Exxon Mobil and Wells Fargo.
A new approach is needed. To succeed in the Digital Age, investors must understand how tech companies function, the source of their competitive advantages, and how to value them. This requires a recalibration of traditional tools and intellectual constructs.
2. Ben Graham's Value 1.0: Asset-Based Investing
As a newcomer—uninfluenced by the distorting traditions of the old regime—I could respond readily to the new forces that were beginning to enter the financial scene.
Graham's framework. Ben Graham, the father of modern security analysis, developed a disciplined approach to investing focused on asset values and liquidation potential. His Value 1.0 strategy involved buying stocks at or below their liquidation value, emphasizing tangible assets over future earnings potential.
Key principles:
- Rigorous research and analysis
- Discipline in price paid
- Scorn for randomness and speculation
Limitations:
- Short-term focus requiring constant portfolio recycling
- Overemphasis on asset prices, ignoring qualitative factors
- Inability to capture the value of businesses with high growth potential
Value 1.0's decline. As the world emerged from the Great Depression, Graham's asset-based system became increasingly ill-fitted to the American economy. The United States became more stable and prosperous, and Graham's system didn't identify businesses whose value resided in their ability to generate large and growing income streams rather than in their net assets.
3. Warren Buffett's Value 2.0: Quality and Brands
The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.
Shifting focus. Warren Buffett, Graham's student, evolved value investing by emphasizing business quality and sustainable competitive advantages. His Value 2.0 strategy focused on identifying companies with strong brands, moats, and the ability to generate growing income streams over time.
Key elements:
- Emphasis on business quality over price
- Focus on competitive advantages (moats)
- Qualitative analysis of management and business models
Brand/TV ecosystem. Buffett capitalized on the brand/TV ecosystem, investing in companies like Coca-Cola and Capital Cities that benefited from strong brand loyalty and the power of mass media. However, this ecosystem is now weakening due to the rise of digital media and changing consumer preferences.
Value 2.0's limitations. The old television network ecosystem is dying, mass brands are moribund, and legacy financial companies have exposed themselves to digital competition through their own bad behavior. Many of these companies, however, look cheap when viewed through the lens of their current price/earnings multiple. But they aren’t cheap because they’re attractive; they’re cheap because their future is bleak.
4. Value 3.0: Moats, Growth, and Management
Ironically enough, the aggregate of profits accruing from this single investment decision far exceed the sum of all the others realized through 20 years of wide-ranging operations in the partners’ specialized fields, involving much investigation, endless pondering, and countless individual decisions.
HEICO as a catalyst. The author's discovery of HEICO, a generic spare parts manufacturer, led to the articulation of Value 3.0. This approach combines the best of Value 1.0 and Value 2.0, emphasizing both business quality and price discipline.
Key criteria:
- Low market share of a large and growing market
- Clearly identifiable competitive advantage (moat)
- Management team that thinks and acts like owners
- Understanding of what drives business value
- A price that gets you under twenty times earnings power, for a 5%+ earnings yield
BMP Checklist. The BMP (Business, Management, Price) checklist provides a framework for evaluating investment opportunities. It prioritizes business quality, management alignment, and price discipline.
5. Competitive Advantages in the Digital Age
The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.
Beyond growth. Rapid growth alone does not constitute a competitive advantage. Many companies experience short-term growth spurts but lack the underlying moats to sustain their success.
Types of moats:
- Low-cost producer: The ability to produce goods or services at a lower cost than competitors (e.g., HEICO)
- Brands: Strong brand loyalty and recognition (e.g., Coca-Cola)
- Platforms and switching costs: Creating ecosystems that make it difficult for customers to switch (e.g., Apple)
- Network effects: The value of a product or service increases as more people use it (e.g., Facebook)
- First-mover or fast-mover advantage: Being the first or quickest to capture a new market
The most powerful moat. Network effects are the most powerful source of competitive advantage in the Digital Age. Companies with strong network effects tend to dominate their markets and generate significant wealth for their shareholders.
6. Management: The Human Element of Value
This is a different world than existed in the past, and I think it’s a world that’s likely to continue.
Management matters. A business's performance depends considerably on the executives who run it. The best managers think and act like owners, prioritizing long-term shareholder value over short-term gains.
Key qualities:
- Stewardship: Putting the owners' interests first
- Financial acumen: Understanding key metrics like return on capital
- Capital allocation skills: Making wise decisions about how to deploy company resources
Tom Murphy as an example. Tom Murphy, the former CEO of Capital Cities, embodies the qualities of an excellent manager. He was frugal, targeted his spending effectively, and understood how to create long-term value for shareholders.
The Mendelson's at HEICO. The Mendelson family, who run HEICO, also exemplify the owner-operator mindset. They have a long-term vision for the company and are deeply invested in its success.
7. Earnings Power: A New Valuation Tool
The world has changed.
Current earnings are distorted. Traditional valuation metrics, like the price/earnings ratio, often fail to capture the true value of tech companies. This is because accounting rules require companies to immediately expense R&D and marketing costs, which depresses reported earnings.
Earnings power defined. Earnings power is an attempt to quantify a digital company's latent, underlying ability to generate profits. It involves adjusting reported earnings to reflect a more realistic picture of a company's long-term potential.
Adjusting the income statement:
- Projecting revenues several years into the future
- Recasting reported earnings to estimate earnings power
- Using comparable companies to triangulate between conjecture and economic reality
Benefits of using earnings power:
- Puts tech companies on a comparable basis with mature companies
- Removes accounting distortions
- Serves as a proxy for a digital enterprise's ultimate ability to produce wealth
8. Navigating the Investment Landscape
The world has changed.
The importance of process. Successful investing requires a disciplined and methodical approach. This involves establishing solid habits, reading widely, and using Mr. Market to your advantage.
Key habits:
- Be quick, but don't hurry
- Extend your circle of competence
- Read widely and consistently
- Use Mr. Market to your advantage
- Invest for the long run and invest incremental dollars regularly over time
Avoiding distractions. It's important to avoid distractions like meme stocks and socially responsible investing, which can lead to subpar returns. Instead, focus on identifying superior businesses and applying the BMP checklist.
The future of investing. The investment landscape is constantly evolving, and investors must be prepared to adapt to new trends and technologies. This requires a willingness to learn, experiment, and challenge conventional wisdom.
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FAQ
What is "Where the Money Is: Value Investing in the Digital Age" by Adam Seessel about?
- Modern value investing focus: The book explores how value investing principles must evolve for the Digital Age, where technology companies dominate and traditional metrics often fail.
- Bridging old and new: Adam Seessel contrasts classic value investing (Graham, Buffett) with the challenges of evaluating digital businesses like Amazon and Alphabet.
- Introduction of Value 3.0: Seessel proposes a new framework—Value 3.0—that integrates business quality, management quality, and price, tailored for tech-driven markets.
- Practical tools and case studies: The book provides actionable checklists and real-world examples to help investors apply these updated principles.
Why should I read "Where the Money Is" by Adam Seessel?
- Adapting to the Digital Age: The book explains why traditional investing tools are often obsolete in today’s tech-driven economy and how to adapt.
- Learn a new framework: Seessel introduces Value 3.0, a disciplined approach for evaluating modern companies, especially those with intangible assets and rapid growth.
- Avoid common pitfalls: Readers learn to distinguish between true competitive advantage and mere growth, helping them avoid overpaying for trendy stocks.
- Real-world application: The book’s case studies and checklists make it practical for both novice and experienced investors.
What are the key takeaways from "Where the Money Is" by Adam Seessel?
- Value investing must evolve: Traditional metrics like P/E and price-to-book often misprice tech companies; investors need new tools.
- Focus on moats and management: Long-term success comes from identifying companies with durable competitive advantages and high-quality management.
- Price is still crucial: Even the best business can be a poor investment if bought at too high a price; adjusted earnings power is key for valuation.
- Compounding and patience: Holding superior businesses for the long term allows compounding to work, even through market volatility.
How does Adam Seessel define Value 1.0, Value 2.0, and Value 3.0 investing in "Where the Money Is"?
- Value 1.0 (Graham): Focused on buying stocks below liquidation value, emphasizing tangible assets and margin of safety.
- Value 2.0 (Buffett): Shifted to prioritizing business quality, durable moats, and management, using current earnings for valuation.
- Value 3.0 (Seessel): Adapts to the Digital Age by focusing on business and management quality, and using adjusted earnings power to value tech companies.
- Evolution of metrics: Each stage reflects changes in the economy, from asset-heavy to intangible, tech-driven businesses.
What is the BMP (Business, Management, Price) checklist in "Where the Money Is" and how does it work?
- Business quality: Assesses if the company has a durable competitive advantage and a small share of a large, growing market.
- Management quality: Evaluates whether executives act like owners, understand value drivers, and allocate capital wisely.
- Price as a veto: Ensures the stock is priced to yield at least a 5% earnings yield (20x multiple or cheaper), using adjusted earnings power.
- Systematic evaluation: The BMP checklist helps investors consistently identify superior companies in the digital economy.
How does Adam Seessel define and use "earnings power" for valuing tech companies in "Where the Money Is"?
- Adjusts for growth investments: Earnings power accounts for R&D and marketing expenses that GAAP accounting immediately expenses, which depresses reported profits.
- Projects future profitability: Seessel looks several years ahead, estimating what a company could earn once growth investments normalize.
- Segment analysis: He assigns realistic operating margins to different business segments, as with Amazon and Alphabet, to better estimate true earnings.
- Enables fair valuation: This approach allows apples-to-apples comparisons between tech and traditional companies.
Why do traditional valuation metrics fail for tech companies, according to Adam Seessel in "Where the Money Is"?
- Accounting distortions: GAAP accounting penalizes tech companies by expensing R&D and marketing immediately, making P/E ratios misleading.
- Heavy reinvestment: Tech firms prioritize growth, so reported earnings understate their true profitability and future potential.
- Asset-light models: Software and platform businesses have few physical assets, making price-to-book and similar metrics irrelevant.
- Need for adjustments: Seessel advocates for adjusting earnings to reflect economic reality, not just reported numbers.
What are the main types of competitive advantage ("moats") discussed in "Where the Money Is" by Adam Seessel?
- Low-cost producer: Companies that can deliver goods or services cheaper than competitors, crucial in commoditized industries.
- Brands: Strong customer loyalty and pricing power, though vulnerable to changing tastes and media shifts.
- Platforms and switching costs: Ecosystems that lock in customers, such as Apple’s iPhone or Microsoft Office.
- First-mover and network effects: Early or rapid market entry and products that become more valuable as more people use them, like Facebook or WhatsApp.
How does Adam Seessel suggest investors evaluate management quality in "Where the Money Is"?
- Owner-like mindset: Great managers prioritize long-term shareholder value and avoid self-enrichment.
- Understanding value drivers: Effective leaders focus on return on capital and smart capital allocation.
- Discipline and transparency: Data-driven decisions, wise investments, and clear communication are hallmarks of quality management.
- Aligned incentives: Modest compensation and significant ownership stakes indicate alignment with shareholders.
How does "Where the Money Is" by Adam Seessel explain the impact of GAAP accounting on tech company valuations?
- Industrial Age bias: GAAP favors asset-heavy companies by allowing depreciation, while tech firms must expense R&D and marketing immediately.
- Depressed reported profits: This accounting treatment makes tech companies look less profitable than they are in reality.
- Distorted valuation metrics: Investors relying on GAAP numbers may wrongly conclude that tech stocks are overvalued.
- Seessel’s solution: He recommends adjusting financials to better reflect the true economic value of tech investments.
What are some examples of companies analyzed using the BMP and earnings power concepts in "Where the Money Is"?
- Amazon: Seessel projects future revenues and assigns realistic margins, revealing Amazon’s true earnings power is much higher than reported.
- Alphabet: The analysis highlights Alphabet’s multiple platforms and network effects, adjusting margins to uncover undervaluation.
- Intuit: Seessel distinguishes between mature and high-growth segments, adjusting for growth rates and margins to make a confident investment.
- Case study approach: These examples show how to apply the BMP and earnings power frameworks to both tech and non-tech companies.
What advice does Adam Seessel offer for younger and older investors regarding technology and investing in "Where the Money Is"?
- For younger investors: Focus on mastering investment techniques and long-term discipline, not just technology trends or trading apps.
- For older investors: Embrace learning about tech companies and engage with younger generations to understand new industries.
- Intergenerational learning: Both age groups have knowledge gaps; bridging them is essential for success in the Digital Age.
- Continuous learning: Seessel encourages ongoing education, industry engagement, and expanding one’s circle of competence.
What are the best quotes from "Where the Money Is" by Adam Seessel and what do they mean?
- Ben Graham on adaptation: “As a newcomer… I could respond readily to the new forces…”—emphasizes the need for fresh perspectives in changing markets.
- Warren Buffett on moats: “The key to investing is… determining the competitive advantage… and the durability of that advantage.”—underscores the centrality of moats.
- Peter Lynch on common sense: “Use your own everyday experience and common sense…”—encourages leveraging personal knowledge and patience.
- Adam Seessel on pragmatism: “I recalibrated my instruments… I did it for the same reason Willie Sutton robbed banks: it’s where the money is.”—highlights the practical motivation for adapting investment strategies.
Review Summary
Where the Money Is presents a new framework for value investing in tech companies, dubbed "Value 3.0". Readers appreciate Seessel's insights on adapting traditional value investing principles to modern tech firms, particularly his analysis of GAAP accounting's limitations. Many found the book thought-provoking and practical, praising its clear explanations and real-world examples. Some critics felt the execution could be improved or disagreed with certain points. Overall, most reviewers recommend it as a valuable resource for investors seeking to understand and evaluate tech stocks from a value perspective.
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