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NOTHING IN INVESTING better exemplifies what the late Donald Rumsfeld called a known unknown than the concept of intrinsic value. The relationship between a company’s current share price and its actual value over its lifetime has always been tenuous—but perhaps never more so.
Before the rise of modern technology, courtesy of Silicon Valley, intrinsic value was difficult to adjudge in a reliable way. Now, ascertaining intrinsic value has become nearly impossible—because “software is eating the world.” Technology is engaged in the capitalist equivalent of the French Revolution, summarily beheading companies. (But hey, at least my BlackBerry makes an excellent paperweight.)
Companies leverage software and artificial intelligence to disrupt legacy business models at a dizzying pace. They operate at massive losses while investors hope their stock prices will one day justify current valuations.
Amid the ongoing disruption caused by competitors, it’s impossible to know whether a company’s growth has entered a terminal decline until several quarters or years have passed. This known unknown inevitably generates massive disparities between a company’s current stock price and the underlying business’s intrinsic value—during both the growth and decline phases of that business’s lifecycle.
Technology has the potential to reduce inefficiencies and boost returns on invested capital. Those who pick the winners will continue to be richly rewarded. But if history is any guide, most investors won’t pick winners.
That’s why using an index fund to capture the intrinsic value of all companies and industries strikes me as more appealing than ever. That way, you can be sure of capturing the returns of the business world’s successful revolutionaries, while avoiding the risk that you’ll bet too much on a future Robespierre.
