There is an old saying in economics that keeps coming to mind in recent months: “don’t throw good money after bad.” In other words, prior investments are sunk costs and are in the past. When allocating new capital, one should look to the future while ignoring the psychological effects of prior failed investments.
Business Models
As discussed in “Amazon is in full bloom,” examining a company’s core business model is at the center of the investment question. In this respect, the essence of the saying is that one should not make new investments in business models that have proven to be failures.
As a company’s business model is the ultimate arbiter of success, it is interesting that the topic garners such little attention in the investment community. In the torrent of information, we risk overlooking the very foundation upon which companies are built.
The following quote from Aswath Damodaran, in an interview with Barry Ritholtz, offers a great deal of wisdom in this regard:
To me, what makes for good valuation is you’re either a disciplined storyteller or an imaginative number cruncher. And I think that combination is getting increasingly hard to find… We can go for a number crunching degree, have a number crunching job. There are no Renaissance people left on Wall Street…
Data, Data, Data
Everywhere you look in the world today, it is all about data and how we can consume more of it. More data crunching can become a mission in itself.
While data crunching is critical, the answers are often found more clearly in words. In fact, given the fixation on data manipulation, there may be more alpha in crunching words today rather than in data. Interestingly, LLMs (Large Language Models) or Generative AI could become a valuable tool in this regard. Afterall, we are a narrative driven society.
Our Company
As an example, the share price decline of BuzzFeed (NASDAQ:BZFD) was brought to my attention recently. As stoxdox is an aspiring media company, I decided to have a look at the company as an investment opportunity.
It was a great reminder that we can often be more data efficient by starting our investment research with the “Our Company” section at the front of the annual report. The following quote is from BuzzFeed’s 2022 10-K filed with the SEC, emphasis added:
BuzzFeed is a premier digital media company for the most diverse, most online, and most socially connected generations the world has ever seen. Across food, news, pop culture and commerce, our brands drive conversation and inspire what audiences watch, read, and buy now — and into the future. BuzzFeed’s mission is to spread truth, joy, and creativity.
The above mission statement and description could be used to describe any number of companies. Given the lack of a clear corporate vision, I quickly moved on to the next opportunity following a curious glance at the balance sheet.
Summary
The concept of not throwing good money after bad should be applied to all capital allocation decisions. Whether or not one personally invested in a company in the past is irrelevant as the calculations remain the same.
In the case of BuzzFeed, only one minute of ‘data crunching’ was required to reach the conclusion that prior investments in the company are highly likely to represent bad money, sunk costs. I imagine we could even train an AI to analyze the words in a nanosecond.
Investors are best served by starting with the essence of a company, the core of its business model, before expending further resources. Could be quite the Renaissance.