Where the Money Is

Value Investing in the Digital Age

Adam Seessel

• Publisher: Avid Reader Press / Simon & Schuster
• Year: 2022
• ISBN:
  9781982185169
• Topic: Personal Development
• Subtopic: Personal Finance

"One of the best books I have read on investing in years. " —Bill Ackman, founder and CEO, Pershing Square Capital Management From a successful investor and a contributor to Barron's and Fortune comes a once-in-a-lifetime book that gives modern investors what they need most: a fresh guide to making money in a stock market now dominated by tech stocks. Technological change is reshaping the economy in a way not witnessed since Henry Ford introduced the assembly line. A little more than ten years ago, only two of the ten most valuable publicly traded companies in the world were digital enterprises—today, they comprise eight of the top ten. Investors around the world are struggling to understand the Digital Age and how they can use the stock market to profit from it.Author Adam Seessel understands. Several years ago, he watched his old-school portfolio built using traditional value investing principles decline while the market, driven by "expensive" tech stocks, advanced. Determined to reverse course, he set off in search of a new investment paradigm, one that remained true to the discipline that Ben Graham gave us a century ago while reflecting the new realities of the Digital Age.In this "helpful take on playing the stock market" ( Publishers Weekly ), Seessel introduces a refreshed value-based framework that any investor, professional or amateur, can use to beat the modern market. Like all sectors, the tech sector follows certain rules. We can study these rules, understand them, and invest accordingly. The world is changing, and we can profit from it.Approaching tech this way, the economy's current changes and the rapid rise of tech stocks are not reasons to be frightened or disoriented—they're reasons to be excited. Infused with the same kind of optimism and common sense that inspired Benjamin Graham's The Intelligent Investor and Peter Lynch's One Up on Wall Street, Where the Money Is ushers in a new era of modern value investing.

PART I Preparing to Invest

CHAPTER 1 The World Has Changed

When I began my career in finance twenty-five years ago, I believed, as most people unacquainted with the ways of Wall Street do, that I was entering a testosterone-filled world of sharks and cowboys who spent their days shouting into telephones and gesticulating on the stock exchange floor in a language only they could understand. As this image suggests, my understanding was muddled. I soon came to learn that what really drove markets was a subculture completely unlike the crude images that I and many others held in our imaginations.

My first job was at Sanford C. Bernstein, a firm known for the thoroughness of its investment research, and its halls were as quiet as a monastery’s. Bernstein had a team devoted to each of the world’s major business sectors—banks, automobiles, pharmaceuticals, and so forth—and the analysts worked behind closed doors. Most reminded me of the professors I’d had in college. Distracted and deep in thought, they would emerge from their offices only to eat or relieve themselves. Kenny Abramowitz, the healthcare analyst, used to walk to the bathroom so fast that his shirttails would come untucked and flap behind him.

The mantras of a good investor, I learned, are the same as those of a monk: study, learn, and practice devotion to your discipline. Good investors do not live by testosterone or adrenaline; they ignore them. Peter Lynch said that his most valuable course in college had nothing to do with finance—it was a course on logic. To relax, Warren Buffett reads the philosopher Bertrand Russell and plays bridge. Buffett guards his thinking time so religiously that, according to his partner, Charlie Munger, his weekly calendar often has only a single activity on it: “Haircut.”

Coming as I was from the world of journalism, this kind of measured, monastic rhythm shocked me. Driven by the news cycle, journalism offers plenty of opportunity for crisis and drama—but there are no deadlines in investing. Urgency, I came to learn, induces poor decisions. Good investors show up at their desks every morning with the goal of slowly advancing their understanding. You sit there and study a business; when you finish, you choose from three alternatives: invest, reject, or, most often, wait and watch. Later, as the circumstances change, so does your opinion; meanwhile, you’ve researched other businesses and formed other conclusions about them. Then the facts surrounding those businesses change, so your conclusions change, and before long you come to resemble neither a cowboy nor a shark so much as a mapper of tides, a riverboat pilot on Mark Twain’s Mississippi.

This slow, incremental approach especially characterizes long-term investors, who don’t see the stock exchange as a gambling hall in which we “play the market.” Instead, we see it as a place where, over time, value is found out. One of my early newspaper mentors, a tobacco-chewing investigative reporter named Pat Stith, used to say, “Sooner or later, you get to be known for who you are,” and the same is true of stocks. The cowboys may ride the momentum and the sharks may circle a hot stock for a time, but in the end such drama has little bearing on what makes stocks appreciate or not. As Peter Lynch has said, superior businesses win in the stock market over time. Inferior ones either languish or die.

Working in the 1980s and 1990s, Lynch was an intellectual descendant of Ben Graham, Warren Buffett’s teacher and the father of modern security analysis. Confronted with the speculative markets of the early twentieth century, Graham imposed an investment discipline onto them. The methods he devised have given generations of investors the chance to approach the market so that positive results stem not from luck, but from a system. Graham’s approach came to be known as value investing, and while the discipline has morphed into different schools and subsets, all of them continue to revolve around a few central orthodoxies. All value investors do their research. All value investors are disciplined about the price they pay. Above all, all value investors scorn randomness; instead, like Graham, we impose a framework onto the markets. We invest using a set of rules that we rarely alter, trusting that our discipline will help us outperform the market averages over time.

At Bernstein, our particular framework was called “reversion to the mean,” which is a mathematical term for the simple idea that life eventually returns to normal. While economic sectors like energy and financial services go in and out of favor in the stock market, reversion to the mean holds that nothing essential changes in the world’s economy. If manufacturing stocks are one day expensive relative to their historical averages, reversion to the mean posits that they will eventually return to a normal, lower valuation. If retail stocks are cheap when measured on historical metrics, they will eventually appreciate.

It’s important to note that “expensive” in a stock market context does not mean a high stock price. Stocks aren’t measured like gasoline or groceries, where it’s axiomatic that a higher dollar value means the goods are more expensive. A business in general, and a stock in specific, is cheap or expensive only relative to something. When judging stocks’ expensiveness or cheapness, investors triangulate between their price and some measure of its value. Ben Graham usually measured price against a company’s net asset value—its assets less its liabilities—while Buffett focuses more on a company’s profit stream.

The reversion to the mean framework measures stocks as Buffett does, comparing a business’s current quoted price to its profits, and the essence of the discipline can be summed up by value investor Sir John Templeton’s dictum, “The four most dangerous words in the English language are ‘this time it’s different.’ ” At Bernstein, this phrase was our Apostle’s Creed. Don’t try to predict wholesale change, we were taught, because it’s not going to happen. Simply buy the companies that are historically cheap and sell the ones that are historically expensive. Eventually, life will return to normal.

I was the junior oil and gas analyst apprenticed to the senior one, and it was our job, along with all the other analysts, to feed data about the companies we covered into what we called “the black box.” This wasn’t a box at all, but rather a sophisticated computer model Bernstein used to determine statistical cheapness using mean reversion calculations. In would go data on projected sales, estimated earnings, debt ratios, and so forth, and out would come the stocks and the sectors that the black box deemed expensive and the ones it deemed cheap. By selling the former and buying the latter, Bernstein filled its clients’ portfolios with well-known American corporations that happened to be on sale. We owned Exxon and BP when energy was out of favor, and we owned Sears and JCPenney when retail was cheap.

Because in the late twentieth century everything did eventually return to normal, the black box generated large gains for the firm and its clients. At its peak, Bernstein managed $800 billion, making us one of the largest money management firms in the world.

The man who presided over the black box when I was there was Lew Sanders, Bernstein’s chief investment officer. Lew was slim and quiet, and he moved through Bernstein’s corridors with the quiet grace of an abbot in his priory. Lew embodied the kind of cerebral, tide-mapping investor I wanted to be. I used to watch him as he stood for hours absorbing information from one of Bernstein’s communal Bloomberg terminals. His eyes were the palest, clearest, and iciest blue I’ve ever seen, and when he was in front of that computer, they were the only part of his anatomy that moved. They would dart left to right, pausing to focus, then move again across the screen. His fingers would periodically flick across the keyboard to access a new dataset, and his eyes would then resume their progression.

This is how real investors hunt, I remember thinking. They don’t move. They stay still and watch.

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When I felt my apprenticeship at Bernstein was done, I left to become a more senior analyst at first one and then another firm, Baron Capital and Davis Selected Advisors. In 2000, I began co-managing a mutual fund for Davis, and by 2003 I felt experienced enough as a value investor to start my own firm.

In my new business, I combined techniques like reversion to the mean with some of Ben Graham’s original methods, like buying stocks at or below their liquidation value. A decade later, I had built a record of beating the S&P 500 market average after deducting my management fees. I was proud of what I’d done, I’d made money for my clients and myself, and I saw little reason why I’d ever have to change.

Then, in the middle of the last decade, my system rather suddenly stopped working.

I remember sitting at my desk in the late afternoon on New Year’s Eve 2014. Unlike Lew Sanders’s gaze, mine was unsteady. First I would look at the Empire State Building, which was glowing cheerfully in the winter gloom; then I would look at a printout of my portfolio, which was not. That year, the market had advanced 13% to 14%, but my portfolio had declined 4% to 5%. You don’t need to know a lot about investing to recognize that’s a huge gap.

All my investments had been made using standard value-investing principles, but none were paying off. I owned shares of Tribune Media, a collection of TV stations and newspapers that could theoretically be liquidated for more than I’d bought the stock. Tribune had recently appointed a young new CEO with a good track record at Fox Broadcasting. Instead of trading upwards to its liquidation value, however, Tribune’s shares continued to decline. I owned shares of Avon Products, the door-to-door beauty company, which also had a poor 2014. Two years earlier, a billionaire family specializing in consumer products companies had offered $23 per share to take Avon private. Avon rebuffed them, the stock declined, and I smelled value. My cost was $12 per share, a knowledgeable private buyer had offered $23, but as 2014 ended, the stock sat at $9.

My portfolio was filled with other such companies. FreightCar America, which made rolling stock for railroads, and Seventy Seven Energy, an oil services company, were classic reversion-to-the-mean stocks, bought because they were cheap relative to historical averages. Experience had taught me that they should soon appreciate—but so far the opposite had happened.

Like all value investors, I was accustomed to stocks initially trading below where I bought them. In the short run, as Ben Graham famously said, the stock market is a voting machine—but in the long run it’s a weighing machine. It’s a place where, over time, the true value of a business gets found out. The essence of value investing is to buy a stock when the market is voting on it, then wait until the market weighs it.

Sitting at my desk that dark December evening, however, I had the uncomfortable feeling that the market had finished weighing my stocks and found them wanting.

The companies I owned shared two characteristics. First, they were all cheap stocks, and historically that had been a good quality. Second, however, all of them likely had their best days behind them. Avon had some growth potential overseas, but door-to-door beauty sales was a declining business in the United States and Europe. Much of the business was moving online. Tribune’s newspapers and television stations were losing huge chunks of advertising revenues to online competitors. Maybe it didn’t matter that the company had a hotshot new CEO. How valuable could Tribune and Avon be if their business models were being undermined by a massive digital shift? What if the businesses I owned were not cheap because they were on sale—what if they were cheap because their futures were bleak?

Like everyone else, I had noticed the rise of the digital applications threatening my legacy holdings, but I had not studied them, largely because they were so expensive. Like most value investors, I scoffed at the high valuations that investors assigned these new-economy enterprises. Earlier in 2014, Facebook had paid $20 billion for WhatsApp, an instant-messaging company founded only five years earlier. Twenty billion dollars—that was double Avon’s and Tribune’s market value combined. But Avon and Tribune generated $10 billion in annual revenues between them, five hundred times more than WhatsApp.

Something is wrong, I remember thinking. Either this is the second coming of the dot-com bubble, or Facebook understands something that I and other old-economy investors don’t. The value investor in me wanted to believe that the four most dangerous words in the English language remained “this time it’s different.” On the other hand, I had to admit that tech’s rise didn’t resemble the dot-com era fifteen years earlier. Tech companies were expensive—but maybe they were expensive for a reason. WhatsApp was on its way to 1 billion users, roughly 15% of the globe’s population. Google generated $66 billion of search-related advertising revenue and continued to grow at a 20% to 25% clip. These and other digital applications had sound business models anchored by what appeared to be sustainable competitive advantages. Every year, they added more users, generated more sales dollars, and entrenched themselves more deeply into the daily lives of their customers.

Could I say the same for the companies I owned, which published newspapers, sold door-to-door cosmetics, and built freight cars? I could not.

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Ever since Ben Graham introduced the discipline a century ago, value investing and technology stocks have not mixed well. They simply haven’t fit any of our frameworks. A reversion-to-the-mean strategy doesn’t work well because tech stocks nearly always look expensive relative to their historical averages. Software companies have few tangible assets and cannot therefore be valued using Graham’s original asset-based analysis. Most importantly, value frameworks prize predictability and stability above all, and until recently tech stocks provided neither to investors.

Until recently, investing in “tech” meant investing in hardware—companies that manufactured PCs, routers, and fiber-optic cable. These businesses proved the wisdom of Buffett’s advice never to confuse a growth industry with a profitable one. A company would introduce a new semiconductor or a new PC, and for a time the money would roll in; then competition would arrive, and profits would implode. The new millennium brought the beginning of better, software-based business models, but the technological infrastructure wasn’t yet robust enough to sustain them. When tech stocks collapsed in the dot-com bust, it confirmed to value investors that the four most dangerous words in the English language were indeed “this time it’s different.” If there was any reversion to the mean in the tech sector, it was to the mean of chaos, and no serious value investor was interested in that.

Fifteen years later, however, something unusual happened. In 2016, Buffett, the guiding light of value investors and the keeper of the flame passed down to him by Ben Graham, bought $7 billion worth of shares in Apple. To say that this move mystified the investment community is like saying Catholics would be confused by a pope who opened the priesthood to women. Apple was a hardware technology company so historically brutalized by competition that in the late 1990s it was ninety days away from declaring bankruptcy. What, the value investing community asked itself, was the Oracle of Omaha doing?

Fortunately, I had a plane ticket to hear Buffett explain himself.

Every spring, 40,000 of value investing’s faithful gather in Omaha, Buffett’s hometown, to hear him and Charlie Munger expound on the state of their holding company, Berkshire Hathaway, and the world at large. Anyone interested in investing should make the pilgrimage to Omaha at least once: Buffett and Munger sit on a dais in a basketball arena and answer a full day of questions, laying out what they invested in over the past year and why. Even though Buffett is ninety-one years old and Munger’s well past that, they remain committed to transmitting the lineage of value investing the old-fashioned way: orally and in person.

By the time I headed to Omaha in May 2017, I had begun to suspect tha...