In a recent interview with Yahoo Finance, Applied Finance Capital Management co-founder Rafael Resendes shares his thought on his firm’s investing approach and on the current state of the value rotation.
Here are some key takeaways from the interview:
- Regarding the rotation to value, Resendes says that in August of last year his firm “really thought value had started to become statistically undervalued” and the style became attractive on a relative basis. But he adds that now, looking at the relative merits of growth versus value, “we see the two styles as approximately equally attractive.”
- Resendes argues that some larger, high-quality mega cap names are trading at “attractive intrinsic valuation relative to their traded share price,” adding that this offers a different perspective than a “traditional value” approach that focuses on a “static multiple that doesn’t properly account for a company’s ability to create wealth and reinvest and become a super compounder.”
- Citing Facebook as an example, Resendes illustrates his point: While in a “traditional growth value dichotomy,” he says, Facebook would not be flagged as a value stock. But he argues that the company “has done such an amazing job generating economic returns on its investment and its ability to reinvest and continue compounding that, well, Facebook is trading at basically the fact that the market’s implying five years from now, Facebook’s sales will be less than it is today. And we think that’s really a compelling story that you’re not going to capture with the static multiple.”
- Resendes explains how his firm calculates intrinsic value by netting cost of capital from operations-based cash flow (adjusted for inflation, R&D expense, and depreciation), then discounting anticipated profits to arrive at the firm’s projected total value. After subtracting total debt, they arrive at equity intrinsic value, which is divided by the number of shares to arrive at intrinsic value per share—which they compare to traded share prices. “We’ve been doing that for 20,000 companies,” Resendes says, “going back to when we started in 1995.”
- While value stocks are typically defined as companies trading below intrinsic value, Resendes points out that due to the surge in share buybacks over the last 20 years, “book equity per se is a really distorted guide” in determining whether a stock is a value or growth stock. “When you look at a book to price ratio,” he argues, “we believe it’s too confusing and provides too many false signals. Unfortunately, there’s no shortcut to getting at what is a value stock. You really have to do the work in getting to an intrinsic value to answer the question.”
- Resendes believes a great opportunity exists to “educate and grow the investment community,” noting that by year-end Applied plans to launch a newly-created website (intrinsicvalue.com) so that “globally, anybody can get online, build a pro forma financial statement and generate estimates of intrinsic value for companies and share it much like you would a tweet, and build kind of an entire valuation community for the world to share.”