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Aging Investment Clubs

07/26/2016

Years ago, I had lunch in the historic Old Ebbet Grill across 15th Street from the White House and next to my office at the corner of New York Avenue in Washington, D.C.  I was with two security analysts – genuine nerds – who got into a rather heated argument as to whether Merck (MRK) or Pfizer (PFE) was a better stock to own.  From memory, they were actually quoting footnotes from the financial statements of the two companies.  I was amazed.

To me, it was the perfect example of classic security analysis, originated by legendary Benjamin Graham in his aptly-named Security Analysis back in 1934, who was incidentally the mentor to Warren Buffett.  He advocated extensive, never-ending analysis of all financial statements.  There is still general agreement among investment analysts that this is very important – important as the basic foundation of general security analysis.

Investment clubs sprouted all over the country, composed of individuals willing to share the work of studying so many different financial statements.  Over time, they earned a good reputation for investment performance, often beating the professionals.  Club members were justifiably proud of their portfolios.  But, their performance has started to falter.  Unfairly, some has suggested the problem is the advanced average age of the investment clubs, but that is incorrect.

The real problem is that basic security analysis started developing after the year 1934, during the industrial age and long before the information age.  (Read Alvin Toffler’s The Third Wave.)  It was during this period that generally accepted accounting standards (GAAP) were also developed.  Despite honest efforts of the accounting standards board to evolve, GAAP just doesn’t help very much in the evaluation of non-industrial companies.

When the company name is so ubiquitous it becomes a verb, like Google (now Alphabet), what is the value of that asset?  When the company name becomes dominant in an industry, like Facebook dominating social media, what is that worth?  How do you amortize the front-end costs of getting new subscribers, like Netflix?  Industrial age accounting is actually an obstacle to evaluating information age stock.

My advice to all investment clubs is to put down the financial statements, take off your bifocals, recruit more teenagers, and actually listen to them.  (I know, I know . . . I don’t like doing that either.)

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