“Notice that the stiffest tree is most easily cracked, while the bamboo or willow survives by bending with the wind”.
– Bruce Lee
In our early biology class, we learn about Charles Darwin, influential biologist and father to the “survival of the fittest” theory; Darwinism. We know that in a given environment, when two of the same species collide, the one with even the slightest edge, be it the bigger horn, muscle mass, the quarter inch bigger claw, will emerge victorious over the long run. As the dominant species reproduce amongst each other, the inferior species will eventually become extinct. All species are subject to natural selection, and it isn’t so different either in the economic world; as “The Nature of Value” by Nick Gogerty parallels the science of economics, evolution and ecology.
To begin, Gogerty discusses the most essential aspect of economics and investing; price in relation to value. Unfortunately, the popular belief that equates value with price foolishly assumes that everything is worth its current price. Price is a reflection of perceived value, and is often, poorly reflected. For instance, the daily changes of stock price means that the perceived value by market participants have changed, but frequently, the firm’s “true” value has not altered. Because the day to day price changes occur, investors slowly forget about the true intrinsic value of the firm, ultimately leading to under or over-valuations of equities.
Another important factor for the allocator is the firm’s competitive advantage. Gogerty draws from Richard Dawkin’s “The Selfish Gene” to illustrate the resemblance between evolution and economics. Organisms have different types of genes, organizations have what the author calls “inos”. Inos are like genes, collecting knowledge and changes that are expressed as an organization’s capabilities. It’s an informational unit, capable of innovation and adding value to a company. Of course, not all inos are value adding; for instance, a mattress store may open-up a drive thru section, but that doesn’t mean it will add positive value to the firm. Therefore, not all inos become sustainable knowledge or useful in a firm’s quest for survival. However, inos that do add value can be reflected in the firm’s competitive advantage; creating additional value.
Another argument draws from Larry Keeley’s “Ten Types of Innovation”, inos improve simple capabilities, and little by little compound to competitive advantages. The 10 capabilities are: business model, networking, enabling process, core process, product performance, product system, service, channel, brand and customer experience. Every firm, according to their industry, will excel in some, while averaging or lagging in some other of the 10 capabilities; ultimately creating its unique position within its competitive environment. The serious allocator should pay close attention to these 10 important aspects when making decisions.
The capabilities of the firms will place them in their own clusters. Gogerty describes 4 types of clusters: Lollapaloozas, Cash Cows, Lotteries, and Red Queens.
The investor should seek the rare “Lollapalooza” cluster; firms that are stable and growing, with few competitors and high barriers to entry. Firms in this type of category have a higher ability to grow revenues and margins. The Cash Cow cluster is dominated by already stable participants, usually with high yields, and high barriers to entry, but limited growth. Lottery cluster can be described as newer firms, fast growth but unstable and low barriers to entry, therefore, these firms do not have established moats and competitors can easily replicate their strategies. Finally, Red Queen cluster participants compete amongst each other in industries that are very capital intensive. This cluster requires participants to continuously exhaust their resources on new innovations and strategies to survive, but most of the value flows to the customers instead of the shareholders. An example of a Red Queen could be the evolution of the TV industry; firms must continuously exhaust their capital to create new strategies and innovate technology or will fall behind, but notice how increasing technology and competition, has added greater value for the customers (with lower prices and greater technology-notice how TVs got cheaper in the past decade?) rather than returning the value to the shareholders. A long-term value oriented investor should avoid the last two clusters (Lotteries and Red Queens).
Lastly, investing based on the nature of value rather than price can help mitigate risk; purchasing moated firms at a discount and holding it for the long-run has proven to be rewarding.
The latter paragraphs were just a glimpse of the distinctive knowledge you will gain from exploring “The Nature of Value“. It is exceptionally informative and well-written, unique in its own league, and deserves a spot in every serious investor’s library.
Finally, finding economic value is the goal of all value-oriented investor. Finding true value is the quest of all human beings. Where should one search for such meaning? Fortunately, there is an answer to your quest; as Gogerty puts it:
“Prioritizing the value of friends, family and freedom ensures that the wealth of a lifetime will be correctly measured in the creation of memories, loving relationships, and a reputation for integrity. Never compromise these forms of value for mere money”.
Put differently; money makes the world go round; but love makes the ride worthwhile.
Thank you for reading. As always, JMO (just my opinion).