Rich Pzena: There’s Something Wrong With The Arithmetic In Today’s Valuations

In his latest presentation, Rich Pzena explains why there’s something wrong with the arithmetic in today’s valuations. Here’s an excerpt from the presentation:

I’m going to start with a little story from 1999. Probably one of the most influential discussions I had as an investor, but to set the stage, we were a fairly young firm. Just in business for a couple of years, and we hit the internet bubble, and for those of you who know what value investing is you know that that’s not a good place to be when everybody’s investing in internet stocks.

We had a period of massively underperforming the markets, and into my office came a woman, a client, who sat down and looked me straight in the eye and started the meeting by saying:

“My grandmother is a better investor than you are. All you have to do is buy Cisco. Everybody in the world has figured this out except for you, and you’re just stubborn.”

I was never phased by that kind of interchange, so I engaged with her and said you know Cisco has a market value of $500 Billion, at the time it was the the most highly valued company in the market, in the world really, and you’re used to making 15% a year, it’s what you’ve been making for the last five years.

So if I was going to buy this whole company and write a check for $500 Billion, to make 15% a year the company would have had to earn $75 Billion per year. They were earning $1 Billion.

So I said don’t you think there’s something wrong with this arithmetic? And she just looked at me and said, “You don’t get it do you!” To which I had to agree. I didn’t get it.

So now I find myself in the same place as I was back then. I really don’t get the arithmetic. It’s really… investing is supposed to be just arithmetic, then it was Cisco today it’s Tesla.

Tesla just became a trillion dollar company. To make 15% a year, if I own the whole company, Tesla would have to earn $150 billion dollars a year. The entire auto industry in the world earns $75 Billion a year. So I’m thinking there’s something wrong with that arithmetic too!

You can watch the entire presentation here: