Our Philosophy About Research

Accounting data was not designed for equity investors, but for debt investors. Accordingly, accounting data must be translated into economic earnings in order to understand the profitability and valuation relevant to equity investors. Respected investors (e.g. Adam Smith, Warren Buffet and Ben Graham) have repeatedly emphasized that accounting results should not be used to value stocks. Economic earnings are what matter because they are:

1. Based on the complete set of financial information available
2. Standard for all companies
3. A more accurate representation of the true underlying cash flows of the business

Why Doesn't Everyone Share our Philosophy?

1. Economic translation of accounting data is very difficult and time consuming. It requires gathering all the relevant financial information, much of which is buried deep in the Notes to the Financial Statements of 300-plus page annual reports and 10Ks.
2. Complacency: Many professional managers are happy with the status quo because they are too rich to care about making changes. They do not see a need for the extra work.
3. Picking stocks in a rising market is easy. As interest rates have declined for most of the past 20 years, the prosperous economic and political environment has given rise to a valuation tide that lifted almost all stocks. Over time, investors have given less weight to the importance of profitability and valuation in our opinion. Until recently, the market has proven them right.
4. Most professional investors are closet indexers (see our blog for more detail). They do not care much about performance nearly as much as the amount of assets they have under management. Because they are content to live off their management fees, performance is not so important. They see no need to invest much time in picking stocks that are not part of a predefined index.
5. The media (and Wall Street via the media) constantly bombard investors with short-term speculative stock recommendations. Constant sensationalism of often trivial data distracts investors from more important analytical work. Many investors become addicted to the news (i.e. multiple TVs blaring constantly in their offices) and believe that they need to watch, read or listen as often as possible. They fear missing important information that could drive them to take investment action every day. "People do not realize that the media is paid to get your attention. For a journalist, silence rarely surpasses [the value of] any word." - Nassim Taleb on page 53 of his book Fooled By Randomness (Texere 2001).