#129: Rafael Resendes - portfolio manager & co-founder of Applied Finance Capital Management

Summary

In this episode, I had the pleasure of sitting down with Rafael
Resendes who is the portfolio manager & co-founder of Applied
Finance Capital Management.


It was pretty exciting to have the co-founder of Applied Finance
on the Intelligent Investing Podcast due to the fact they have
become a thought leader in valuation and portfolio construction
in the value investing community. You could say they are the real
deal.  Unlike the majority of firms today that focus on low
multiples to define “value”, they define value as identifying
companies trading below their intrinsic value. Their Valuation
Driven approach forms the foundation of their investment
decisions.


Applied Finance is 100% employee-owned, with the average tenure
of our 10 partners being over 18 years.
History of Innovation

Research has always been a critical part of Applied Finance’s
culture.  In 1995, they humbly began in a Chicago basement,
with the idea to create a better approach to measuring corporate
performance and value companies than existed at the time.


Their roots were and remain dedicated to answering two questions
critical to any investment decision:


What is a firm’s economic performance?

What is a firm worth?



They developed the Economic Margin framework to measure a firm’s
economic, rather than as-reported accounting performance, leading
the industry with primary research into:


Capitalizing R&D

Estimating size and leverage risk premium

Modeling competitive advantage through Economic Profit
Horizon



Ultimately, creating a direct link from corporate performance to
valuation.


Shortly thereafter, they began assembling a technical team that
today includes a unique mix of professionals with diverse
functional, educational, and cultural backgrounds.  The
result is a special workplace that values: accomplishment,
stability, and ethics in the pursuit of excellence for our
clients.


Since 1995, they have calculated over 20 million out of sample,
point-in-time, company valuations.  Each week they add
approximately 20,000 additional intrinsic value estimates to
continually expand their knowledge and improve their strategies.


Their proprietary research analytics provide the foundation for
our repeatable and sustainable investment process.
Philosophy

His firm aims to buy stocks trading below their intrinsic value
which forms the foundation of their strategies.


As obvious as that phrase seems, he believes there is much to
appreciate in its meaning and implementation that is too often is
either ignored and/or misunderstood in the value investment
community.


First, he focuses his efforts on understanding a firm’s intrinsic
value, not its cheapness. Cheapness investing, encompassing the
Fama/French value factor among other low price to something
metrics, has become extraordinarily popular over the past 30
years.  While there has been an abundance of academic
research and marketing expenditures promoting such styles, the
research and messaging behind this approach is fundamentally
flawed. After controlling for whether a stock is over or
undervalued as measured by Applied Finance’s Intrinsic Value
Factor, cheapness provides little to no achievable excess
returns. The “low price to something” investment managers know
such metrics do not represent intrinsic value, instead, they hope
the stocks they buy are correlated to companies trading below
their intrinsic value. Each week, Applied Finance calculates the
intrinsic value of every stock in the investable universe of each
strategy they support to determine the stocks providing the most
attractive future expected returns at any point in time to
identify candidates for inclusion into our strategies.


Second, his company actively cultivates a vibrant valuation
culture within their investment group through an ongoing
commitment to:


Develop and maintain a deep professional expertise

Perform ongoing theoretical and applied valuation research

Continually review our valuation efficacy.



Lastly, while it is easy for an investment manager to claim they
perform valuations as part of their research process, it is
important to understand that performing a valuation is actually
very easy, it is only simple algebra. In contrast, it is
extraordinarily difficult to consistently perform valuations that
identify companies trading above and below their intrinsic value,
which can be purchased or sold short to generate alpha at the
portfolio level.


Unlike any other firm, Applied Finance over the past 25 years has
developed and maintained original, proprietary research to
properly model equity risk premiums and Economic Margin
sustainability, which they call Economic Profit Horizon. This
enables them to avoid the unrealistic assumptions common to most
valuation approaches practiced today.


In addition, they archive 20,000 valuations weekly, over 20
million since 1995, that allow them to understand how well they
value the stocks they own in their portfolios and just as
importantly those they do not so they continually learn and grow
our knowledge base from our mistakes.


This enables them to avoid the unrealistic assumptions common to
most valuation approaches practiced today.


 
About Eric Schleien

Over the past decade, Eric has trained thousands of individuals
including board members of public companies as well as several
Fortune 500 CEOs. Eric specializes in organizational culture and
has become a leading authority on organizational culture in the
investment industry.


Eric has been investing for 15 years and has been using
breakthrough coaching methodologies for over a decade. Eric had
the insight to combine proven coaching methodologies with
shareholder activism techniques to create an entirely new model
for shareholder activism that was more reliable and created
greater sustainable results in a rapid period of time. On
average, Tribal Leadership produces a 3-5x increase in profits of
culturally troubled companies within an average of 24 months or
less.


Eric currently resides in Philadelphia, PA.
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