This video interview of Nick Gogerty by Jake Taylor is a great introduction to some of the important ideas in Gogerty’s book The Nature of Value. Looking at value in this way will lead us to be better investors in businesses, and not simply traders of tickers. This is really a fascinating and wide-ranging interview.
Some of Gogerty’s main points from his book are:
1. The economy is an evolutionary, adaptive system that selects and evolves for greater and greater value creation over time.
2. Value is important because it is closer to economic truth than price.
“Value, in the simplest sense, is the human perception of what is important.”
— Nick Gogerty
3. Value is a process and not just a static entity.
“We should look not just at life and at value as static entities, but at life and value as continuous flows through a system that adapts for greater and greater flow capacities.”
— Nick Gogerty
4. Experience curve effects are one of the main mechanisms for increasing efficiency and value creation in a company, a cluster, and an economy.
5. Identifying companies with sustainable economic moats is key to the nature of value approach to investing. This requires us to understand the dynamics of the business, as well as, how the business interacts with other companies within its cluster to compete and create value.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. The products or services that have wide, sustainable moats around them are the ones that deliver rewards to investors.”
— Warren Buffett
6. Clusters exhibit periods of “punctuated equilibrium” that last for a period of time, and are followed by periods of upheaval, and eventually a new temporary equilibrium.
7. Key to investing well is choosing companies in stable clusters with a slow rate of change in strategy and capabilities. This would include the Lollapalooza and Cash Cow clusters.
Companies in innovative clusters with fast rates of change in products and capabilities are many times not great places to invest, such as with the internet boom at the turn of the century. A lot of value was created, but most of it flowed to customers, and not to companies within the cluster. This is a key insight, and is worth the price of the book to me. The following chart shows the matrix of cluster types according to cluster stability and life cycle stage.
8. Return on capital is more important to value creation than absolute growth in revenue and profits at lower rates of return.
If additional capital can only be deployed at lower and lower rates of return, capital should be returned to shareholders so they can allocate it to higher return areas. Otherwise, value is destroyed.
Gogerty on the Prerequisites for Prosperity
Soft infrastructure like property rights and the rule of law are key for prosperity and the nature of value approach to work. The lack of these is the main reason for the appalling human suffering in much of Africa. The best anti-poverty program in the world is to create such soft infrastructure. This explains why years of foreign aid to Third World countries has had little positive impact as corrupt elites embezzle aid and stifle the value creating capacities of the common people. Thus, the nature of value approach is really a moral and human imperative, and not simply a device to make money for yourself.
The Problem With Keynesian Aggregation and The Attempt to Reduce Economics to Arithmetic Formulas
Gogerty’s approach highlights a blind spot of many Keynesians who suggest that companies should just throw more money at plant and equipment and invest for growth. This mechanistic, aggregationist approach, which seeks to reduce economics to arithmetic formulas where more inputs equals more outputs, ignores the true evolutionary nature of an economy. Rather, return on capital is crucial for value creation, which leads to success for companies and economies, as well as, overall societal well-being. Capital discipline, and not growth at any cost, should be the aim for CEOs and allocators. Otherwise, value will be destroyed and well-being will decrease.
“The historical evidence strongly suggests that expected future earnings growth is fastest when current payout ratios are high and slowest when payout ratios are low….Our evidence thus contradicts the views of many who believe that substantial reinvestment of retained earnings will fuel faster future earnings growth. Rather, it is consistent with anecdotal tales about managers signaling their earnings expectations through dividends or engaging, at times, in inefficient empire building.”
— Rob Arnott and Cliff Asness