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As the market continues to set new highs and passive investors allocate capital to companies whose fundamentals are disconnected from their trading prices, understanding the expectations priced in and following a disciplined valuation process has become more important than ever. Take for example the Russell 2000, the meme stock AMC is the largest holding! AMC does not earn their COC and has expectations that are unachievable, setting passive investors up for failure.

Active managers that focus on Valuation and Wealth Creation can exploit the misallocation of capital by passive investors either through stock selection or a fundamental valuation weighting.  Derek Bergen, CFA shows that passive indexes built on size allocations can be significantly improved by changing the weights of the companies to an intrinsic value weighted approach.  By also avoiding companies that dilute shareholder value, returns are further improved with lower standard deviations.

Jun Wang, CFA mentions some recent short-term trends (memes, SPACs, Crypto etc.) in our quarterly writeup and how they have affected short term outcomes. However, she reminds us that “wealth accumulation is a marathon, not a sprint” and that focusing on Valuation (done properly) & Wealth Creation has never gone out of style.  It is important to remember that Valuation and Wealth Creation are long-term indicators rooted in fundamentals, however, there are times when style shifts offer unique opportunities for investors.

Let’s review the guidance Applied Finance has given since the pandemic:

While we cannot predict the short-term volatility in markets, we are confident that these principles will withstand the test of time.

Don’t follow the trend, be the trend!

Chris Austin (@CAustin34)
Applied Finance, Partner

The Valuation Edge™ Newsletter Articles:

Looking Back, Looking Forward – 2021Q2

We continue to believe for investors with long term horizon, investing in companies with attractive valuation, credible management team, strong wealth creation track record and strategy is key to outperformance. Even in the past 6-7 short months, we have witnessed the quick boom and bust of multiple themes such as lumber, SPACs, crypto currency, and the ebb and flow of semiconductor stocks’ fortune, to name a few. Wealth accumulation however is a marathon not a sprint.

FAAMG Stocks: Valuation & Concentration

Many market participants presume that the FAAMG stocks are due to underperform based on their large market caps, expensive GAAP accounting-based price multiples and high rates of investment, but intrinsic value characteristics indicate that these stocks continue to offer material upside potential despite their collective outperformance over the last several years.

Tactical Valuation – Update July 2021

In this update, we explore the valuation upside of various value and growth methodologies. We also observe large cap US stocks have improved upside vs. small cap peers. High profit, reinvesting stocks offer attractive upside vs low profit, dilutive peers.

Valuation and Wealth Creation’s Enhanced Capital Allocation Line

The foundation of passive investing assumes that diversification with all stocks (regardless of valuation attributes) is beneficial by lowering risk. The improved capital allocation line attributed to intrinsic value weighted portfolios provides evidence of the strategic benefit of incorporating intrinsic value and wealth creation principles into portfolio construction.

Tesla/Long Duration Stocks

Paul Blinn discusses whether it makes sense that Tesla’s market cap has exceeded the total capitalization of all its automotive peers and the entire energy complex. He also touches on the hidden risks of long duration stocks.

Market in Pictures #8

Paul Blinn compiles the best of Twitter in market charts, valuation info and other interesting facts for the month of July.

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