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The Nature of Value

The Nature of Value: How to Invest in the Adaptive Economy

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  • Book Info
    The Nature of Value
    Book Description:

    The Nature of Valuepresents a theory of how economic value functions and how it drives growth, starting with tiny sparks of innovation and scaling all the way up to the full scope of the economy. Nick Gogerty's exploration of value borrows from a wide array of disciplines, including anthropology, psychology, physics, sociology, and ethics, but most of all, it examines how evolution's processes can help investors understand the economy and how investors can use this new understanding to improve their allocation decisions.

    Starting with a look at how innovations can help firms succeed, Gogerty looks at the economic niches in which firms compete and explores how firms can create defensive "moats" to enhance their chances of survival. He shows allocators how to adjust their actions for best performance and returns and what to look for when assessing company management, supporting his arguments with extensive data and years of practitioner experience from scientific, social, and economic disciplines. Intuitive illustrations are used to illuminate central concepts and ideas. Gogerty's practical takeaways, couched in vivid explanations, will help investors of all backgrounds gain fresh insight into market mechanics.

    eISBN: 978-0-231-53521-2
    Subjects: Business, Finance

Table of Contents

  1. Front Matter
    (pp. I-VI)
  2. Table of Contents
    (pp. VII-X)
  3. Preface
    (pp. XI-XVIII)
  4. Part I: Value

    • Chapter One The Problem with Price? It’s Not Value
      (pp. 3-15)

      ON MAY 6, 2010, the shares of technology services consulting firm Accenture crashed from $40 to $0.01 in three minutes, wiping out 99.99 percent of its $35 billion market capitalization. Simultaneously, other companies’ share prices gyrated wildly. The combined impacts reflected a $1 trillion loss, measured in share prices, or 9 percent of the index value. Minutes later, the share prices had mostly recovered.

      This speedy decline and subsequent bounce back was called the “flash crash.” Although this flash crash was notable for its size, miniature flash crashes of 5 to 30 percent, with subsecond price recoveries, occur surprisingly frequently....

    • Chapter Two Value and Why It Matters
      (pp. 16-32)

      VALUE, IN THE SIMPLEST sense, is the human perception of what is important. As such, it is subjective and context dependent. Value is experienced in many forms, from the physiological—food, water, shelter—to the experiential—music, art, sport—to the psychological desires for social position, freedom, creativity, and love. The individual and group choices we make to organize and collectively maximize value are the major concerns of the economics field.

      Economic value starts with basic physical needs. Food keeps you alive, clothing keeps you warm, and shelter keeps you safe. These things provide functional physiological value, and are found...

    • Chapter Three The Theory of Value
      (pp. 33-52)

      THIS CHAPTER IS THEORETICAL and less directly applicable to investing. It examines the underlying macroprocesses forming both the economy and ecology. Those wishing to skip the theoretical underpinnings of nature of value investing may skip this section. For others, it may help give a deeper and more substantial understanding of value.

      In order to truly grasp the power of evolution’s process and its relationship to economic value, it’s important to first set straight a few common misperceptions about evolution. First, evolution is often incorrectly summed up as “survival of the fittest.” It’s not quite as simple as this. Rather, evolution...

  5. Part II: Inos

    • Chapter Four Knowledge and Innovation
      (pp. 55-70)

      APPLIED KNOWLEDGE CREATES the economic value we experience. Adapted knowledge—innovation—creates the new forms of value that drive economic growth. Adaptation, competitive selection, and replicated knowledge are all the result of evolution at work in the ecology and economy.

      In his bookThe Selfish Gene, biologist Richard Dawkins gave people a new way to think about DNA—the knowledge carrier of the biological realm. Genes, Dawkins wrote, can be thought of as selfish. The gene’s one aim is to replicate itself, with various organisms acting as mere vehicles to fulfill the gene’s objective of replication. The selfish gene rhetorical...

    • Chapter Five How Innovative Capabilities Enable Value Creation
      (pp. 71-88)

      UNIQUE CAPABILITIES that can provide a competitive advantage and a propensity for reproductive success are the only ones that count for organisms or organizations. A lobster may grow an extra eye, which is certainly unique but may not provide an advantage in the gene replication game. By the same token, a furniture store may decide to open a drive-through window for ordering, but it probably won’t help the chances for replicating the store’s accumulated inos. Thus not all inos become sustainable knowledge; those inos that don’t increase their propensity for information survival and replication don’t add value to an organization’s...

    • Chapter Six Allocating to Firms with a Unique Capability Mix
      (pp. 89-98)

      A FIRM’S MIX OF CAPABILITIES determines its survival chances in the economic wilds. Companies focused on one unique capability or product are vulnerable to negative option forces. Firms possessing many categories of unique capabilities have a greater chance to grow and thrive.

      For the capital allocator studying an organization or project, the first thing to look for is survival potential, and the second is the organization’s ability to thrive. This can be distilled to a handy maxim: First, don’t lose value-creating capabilities, and second, make those capabilities grow. New technology and innovation is exciting, as it is the future and...

  6. Part III: Clusters

    • Chapter Seven Birth and Growth of Clusters
      (pp. 101-125)

      IN ORDER TO RESPONSIBLY allocate capital, the investor must understand how a business beats or avoids competition over the long term. The competition that a firm faces determines how much excess value it captures as profit, with profit effectiveness measured as the best return on allocated working capital (ROC). The firm’s competitive space is called the cluster.

      The competitive cluster for a good or service is equivalent to the niche in an ecosystem. A niche is the multi-variable space in which an organism functions, and includes its network of links to food, resources, relationships, and physical environment. Network niches are...

    • Chapter Eight Cluster Convergence, Maturation, and Death
      (pp. 126-140)

      AFTER A MATURE FOREST BURNS DOWN, and nothing remains but charred topsoil, there is a standard growth pattern and cycle for the way species repopulate the forest. The first returning species are fast-growing grasses and shrubs. These opportunistic fast growth species provide low groundcover. Next, small softwoods start to fill in, also growing quickly and providing some shade canopy. Finally, the slow-growing hardwood trees begin to reappear, offering significant canopies over decades or centuries.

      At each phase of development, different organisms are best suited for the network of available ecological resources. Grasses thrive in the bright light and can withstand...

    • Chapter Nine Stable and Unstable Clusters
      (pp. 141-166)

      EACH CLUSTER MACROPROCESSES AS A SMALL living network with a unique pulse, of participants, suppliers, and customers coadapting; the cluster and network becoming more complex and efficient at transferring value into the economy. Allocating involves picking a cluster capable of supporting a great company. Even the strongest, most capable animal can’t survive in the wrong environment or niche context. The ideal habitat is stable, providing the right context and resources for a firm to survive and thrive.

      Stable clusters, like stable niches in ecology, are places where value flows without being interrupted by too much change. Clusters often converge towards...

  7. Part IV: Moats

    • Chapter Ten The Value of Moats
      (pp. 169-187)

      FOR AN ALLOCATOR, success means investing in firms with sustained positive returns on capital in excess of inflation. Sustained 20 to 30 percent ROE in a low-risk, long-term stable environment are highly desirable. A moat occurs when some or all of a firm’s capabilities combine, creating sustainable high margins. The confluences of capability and behaviors that lead to moats are exceptionally rare.

      All moated firms share three traits:

      1. A unique mix of capabilities not shared by any competitor

      2. The ability to capture high margins, using pricing power relative to competitors

      3. Durability to survive over multiple competitive product...

    • Chapter Eleven How Moats Affect Cost, Competition, and Customer Forces
      (pp. 188-205)

      MOATS REDUCE THE SELECTIVE competitive pressures associated with three things: cost, competition, and customers. Some moats reduce pressures in just one area, whereas others can impact all three. Moats are formed when a combination of capabilities from the ten types of innovation lead to unique high-margin businesses with relative pricing power. Figure 11.1 highlights how capabilities and margins expand the economic boundaries of organizations and clusters.

      To survive, a firm’s cost, price, and the value delivered to the customer have to obey the Cost < Price < Value delivered relationship.¹ Figure 11.2 combines the earlier capability and cluster diagram to...

    • Chapter Twelve Managing Moats, for Value Creation Today and Wealth Tomorrow
      (pp. 206-216)

      GIVEN TIME, all businesses get the share price they deserve. Many investors wrongly believe that management’s job is to increase the share price. But management shouldn’t be focused on promoting opinion-based metrics like share price; they should be focused on processes and capabilities that grow value. Swaying opinions to drive short-term share price spikes doesn’t grow intrinsic company value. Stock prices may increase temporarily with earnings spikes and accounting games, but these acts are short-term cheap magicians’ tricks of misdirection.¹

      Managing capabilities, execution, and returns on capital sustainably requires a focus on long-term payoffs. Innovation-driven moat change typically unfolds at...

  8. Part V: The Economy

    • Chapter Thirteen The Economy as a Macroprocessing Network
      (pp. 219-243)

      NOW THAT WE’VE COVERED all the principal components of the economic panarchy, it’s time to take a look at how everything fits together forming the organized economy as a whole, defining the Nature of Value approach to understanding the economy. But before looking at the economy as a whole, it might be helpful to quickly review each level of the economic panarchy, shown in the following list (fig. 13.1).

      1.Inosare units of information that get expressed as organizational capabilities and behaviors. They are analogous to biological genes. Surviving replicated inos reflect accrued knowledge that has been competitively selected,...

    • Chapter Fourteen Monetary Shocks and Their Implications for the Allocator
      (pp. 244-298)

      WITH THESE GENERAL ECONOMIC trends and types of economy in mind, let’s take a closer look at how the nature of value approach may help us understand economy-wide events, such as inflation, deflation, and other major economic shocks. Being able to identify and even potentially anticipate these events can help allocators find unexpected investing opportunities, and can also help the thoughtful allocator recognize when it’s best to avoid getting involved.

      However, before delving into this discussion, let us return to a topic touched on in chapter 1—the difference between price and value. This relationship is essential when it comes...

  9. Part VI: The Nature of Value

    • Chapter Fifteen The Nature of Value Allocation
      (pp. 301-316)

      THE NATURE OF VALUE APPROACH to investing informs the allocator’s understanding of economic value flows, from the smallest unit of information (the ino) to seeing the entire interconnected economic network acting as one of evolution’s adaptive network panarchies creating ever-increasing Φmcapacities. There are some practical ways a nature of value approach can improve your allocating success. Here are a few thoughts on the implications for allocators.

      The economic and ecological domains are like hits-based businesses; over time, one either makes a killing or gets killed. There isn’t a lot of sitting around, and things are constantly either growing or...

    • Chapter Sixteen Conclusion
      (pp. 317-318)

      NEW IDEAS AND INFORMATION are often rightfully ignored, as 99 percent of innovations fail or fade away quickly. Hopefully a few ideas presented here have provided you with a new view on the origins, flows, and creation of economic value. The ecology and economy are beautiful examples of evolution’s adaptive process, but they don’t lend themselves to easy explanation. The rhythms and cycles flowing through an economy, like the rhythms and cycles of an ecology, are too complex to fully understand, too powerful to ignore, and too wonderful and fascinating not to appreciate. The physicist Rolf Landauer put it well...

  10. Notes
    (pp. 319-334)
  11. Index
    (pp. 335-348)