Why Fundamentals Fail the New Economy | Jacob Pozharny on “Sentiment” Analysis’ Role in New Economy Stocks
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Today's episode is brought to you by the Unlimited HFGM Global Macro ETF, ticker HFGM. Later in the show, you'll hear more about HFGM, currently the number one Morningstar rated fund since its inception in The US macro trading category. Let's get into it. I'm joined today by Jacob Pajarney, co chief investment officer at Bridgeway Capital Management and the portfolio manager at the Global Opportunities Fund. Jacob, welcome to Monetary Matters.
Hey, Jack. Thank you very much for having me and your interest in Bridgeway as well as our strategy.
I wanna start by defining a few terms. What are new economy stocks? What are old economy stocks? You you do a lot of types of analysis, fundamental analysis and then sentiment analysis. So could you define those four terms before we begin?
Sure. Sure. So what we've noticed is number of years ago, especially after the GFC, we had issues, and a lot of investors had issues investing based on discounted cash flow methods, on fundamental analysis, because the the metrics that we all were accustomed to using became flawed in the way that they were measured because of the level of intangible assets in the companies that we are investing in. There's a lot of books written on this point by Demicks. One is end of accounting. What he finds and what we confirm and extend to international markets is that the the cross section, fundamentals h
So what you're saying is that old school fundamental analysis, the company's trading at a price to earnings ratio of six, and it's growing earnings really well. It's a good company. Nothing's wrong with the company. Let's make it happen. That that doesn't work as well, particularly for the news new technology stocks. Just how much does it not work? And if people were to take a model of value investing that they were doing in the nineteen sixties and seventies, you know, Warren Buffett and the like, and apply it to today's technology stocks, just how far behind would they be?
Let me show you a chart to help bring some of these points home. And this is something that we monitor constantly, and it's something that we've published on extensively. So there's this, model called the PBROE model. It's a statistical discounted cash flow analysis that folks used in the 1980s and 1990s, and they felt like it broke down because it failed to be predicted. Now we've done this. We've extended that work, and we showed that for low intangible industries, the classical relationship between valuations and profitability continues to hold, while for the new economy behind tangibles, t
So high return on equity stocks, that is to say companies that can earn high rates of return on the book value, the on the company, the capital that they have in the company, they deserve a higher multiple, a higher price to book multiple, let's say. And that metric, that rule holds very well for household products, consumer discretionary, durables, autos, real estate. But when you come to the new economy stocks, so that's pharma, semiconductors, software, that that relationship breaks down, and it actually is somewhat negative. So so pharma has a very low return on equity approaching zero, an
Well, because the earnings and the book value don't really take into account the intangible assets. When a company does r and d work, what that does is it directly impacts earnings. It reduces earnings. If it does it over a course of time, it decreases the overall book value of the firm. So that investment in R and D, in fact, makes a company look very expensive. And the financial statements don't really capture that value becaus
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