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Philosophy / Valuation Driven™ Investment Process

Buying stocks trading below their intrinsic value forms the foundation of our strategies.

As obvious as that phrase seems, we believe there is much to appreciate in its meaning and implementation that is too often is either ignored and/or misunderstood in the investment community.

First, we focus our efforts on understanding a firm’s intrinsic value, not its cheapness. Cheapness investing, encompassing the Fama/French value factor among other low price to something metrics, has become extraordinarily popular over the past 30 years.  While there has been an abundance of academic research and marketing expenditures promoting such styles, the research and messaging behind this approach is fundamentally flawed. After controlling for whether a stock is over or under valued as measured by Applied Finance’s Intrinsic Value Factor, cheapness provides little to no achievable excess returns 1 . The “low price to something” investment managers know such metrics do not represent intrinsic value, instead they hope the stocks they buy are correlated to companies trading below their intrinsic value. Each week  Applied Finance calculates the intrinsic value of every stock in the invest-able universe of each strategy we support to determine the stocks providing the most attractive future expected returns at any point in time to identify candidates for inclusion into our strategies.

Second, we actively cultivate a vibrant valuation culture within our investment group through an ongoing commitment to:

  • Develop and maintain a deep professional expertise
  • Perform ongoing theoretical and applied valuation research
  • Continually review our valuation efficacy.

Lastly, while it is easy for an investment manager to claim they perform valuations as part of their research process, it is important to understand that performing a valuation is actually very easy, it is only simple algebra. In contrast, it is extraordinarily difficult to consistently perform valuations that identify companies trading above and below their intrinsic value, which can be purchased or sold short to generate alpha at the portfolio level.

Unlike any other firm, Applied Finance over the past 25 years has developed and maintained original, proprietary research to properly model equity risk premiums and Economic Margin® sustainability, which we call Economic Profit Horizon™. This enables us to avoid the unrealistic assumptions common to most valuation approaches practiced today.

In addition, we archive 20,000 valuations weekly, over 20 million since 1995, that allow us to understand how well we value the stocks we own in our portfolios and just as importantly those we do not so we continually learn and grow our knowledge base from our mistakes.

This enables us to avoid the unrealistic assumptions common to most valuation approaches practiced today.