Sponsored by Distillate Capital 
The composition of our economy and stock market have shifted enormously over the past several decades. Previously, companies generally derived their value from the ability to produce products from large physical plants, but today they increasingly generate their free cash flow from intellectual assets like software, proprietary algorithms, brands, patents, supply chains, customer networks, etc. This evolution and differences in accounting for physical versus intellectual assets has led to wide gaps in how these companies look on traditional valuation metrics like price-to-book or price-to-earnings. In this paper, we discuss how this economic transformation and the accompanying accounting issues have made traditional valuation metrics less comparable and less meaningful in today’s economy. We also describe methods to circumvent these distortions to re-enable meaningful valuation comparisons across companies in the market regardless of whether they are engaged more in physical or intellectual activities.
When you’re finished, you’ll understand:
- Why claims that value investing isn’t working are getting confused by definitional issues.
- How the economic shift from physical to intellectual assets is impacting traditional valuation metrics.
- That value indices and funds that follow them may not be achieving the investment style implied in their names.
- How to avoid these distortions to once again compare equity valuations across the market in a meaningful way to identify underpriced securities.
