Mauboussin on Popular Delusions and Myths

In a talk given in January to the Greenwich Roundtable (a non-profit organization that provides independent education for investors), Michael Mauboussin of Counterpoint Global debunked the following four investing-related myths:

  • Short-termism is harmful.
  • Dividends play a large role in equity returns.
  • Investing in money-losing companies is “a bad idea.”
  • The rise in indexing has made it easier to be an active manager.

Here are key takeaways from Mauboussin’s talk:

Short-termism is harmful: Mauboussin argues that a shorter time horizon may be “fully justified by the economic facts,” citing how the composition of the economy and the stock market “have shifted away from asset-heavy to asset-light industries” and asset lives have shortened over time (i.e. 6-7 years for tech companies compared to 17-18 years for energy and materials companies). He also highlights share valuations as an indicator that the market is “recognizing and paying for cash flows many years into the future,” the opposite of short-termism. He supports the argument through a calculation of the present value of expected dividends of five stocks from the Dow for a five-year period. The calculation shows that “most of the value is reflected in long-term cash flows.”

Dividends play a large role in equity returns: Mauboussin argues to the contrary: “In reality, price appreciation is the only source of investment returns that increases accumulated capital.” He contends that total shareholder return calculations often assume that dividends are automatically reinvested, which is very rarely the case.

Companies losing money: According to Mauboussin, it’s important to understand the reasons for decreased earnings, which result from what he describes as a “watershed change” in how companies invest and a shift toward higher intangible investment. In the 1970s, he explains, tangible investment was much higher, and those investments appeared on a company’s balance sheet. Intangible investments, on the other hand, appear as an expense on the income statement. If intangible investments appeared on the balance sheet, it would result in an immediate earnings boost (the expense would be eliminated). This situation has created an opportunity for investors to better understand underlying economics of businesses, says Mauboussin. “Some companies today are losing money but have extremely attractive economics, and others are losing money the old-fashioned way—with bad business models.”

Rise in indexing makes active management easier: While the fact that “fewer people are competing and less information is finding its way into markets,” might make it seem that active managers will be able to show their skill in finding mispriced assets, Mauboussin argues to the contrary. He likens index investors to weaker players in a poker game and argues that the increase in indexing means active managers are “left playing the stronger players, making it harder, not easier to generate risk-adjusted excess returns.”