Tuesday, January 18, 2011

Monks and Lajoux, Corporate Valuation for Portfolio Investment

Corporate Valuation for Portfolio Investment: Analyzing Assets, Earnings, Cash Flow, Stock Price, Governance, and Special Situations by Robert A. G. Monks and Alexandra Reed Lajoux (Wiley, 2011) is a surprisingly engaging book. And, let me confess up front, I have spent mighty few waking hours worrying about how to value corporations. Early on in my investing career I admitted defeat: I had no idea how to make sense of the conflicting valuational models.

The authors bring years of academic training and involvement in the corporate and investment worlds to the task of explaining corporate valuation. Monks, the founder of Institutional Shareholder Services and Lens, is the product of Harvard College, Cambridge University, and Harvard Law School. Lajoux, chief knowledge officer at the National Association of Corporate Directors, has a Ph.D. in comparative literature from Princeton. I assume that she’s largely responsible for making the book read so well.

All methods of valuing functioning corporations, the authors suggest, are attempts to quantify hope—or, in the emotionless language of value investing, attempts to determine the present value of future worth. Done properly, valuation steers a middle course between “tire-kicking,” the appraisal of business assets, and “gambling,” ungrounded speculation. Described somewhat differently, “value lies somewhere between these two extremes of absolute and relative value—or, if you will, between economic value and market value.” (p. 31)

The authors steer the reader, seemingly effortlessly, through the basic valuation models based on assets, earnings, and cash flow. They then move on to valuation based on price where technical analysis, though important, is not the only game in town.

Drawing on the theoretical work of the senior author, Monks and Lajoux offer a different approach to “valuation guidance based on six factors: genius, liberty, law, markets, governance, and values.” (p. 292) This clearly is where their hearts lie; it provides a “big-picture” approach to valuation.

The authors conclude that there is no absolute definition of valuation. “The need for valuation exists in many contexts that have irreconcilable frames of reference…. As a result, valuations of the same security can vary widely. Although each may be appropriate to its intended purpose, the resulting disparities create confusion and no small degree of skepticism regarding the whole language of valuation.” (p. 397)

This book goes a long way toward reducing (or, some might argue, refining) that skepticism. It is lucid, comprehensive, sometimes even passionate. It is a book that every value investor should read. Because, in the end, there’s no substitute for investor knowledge and talent.

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