The Evolution of Investment Analysis

“The world of finance hails the invention of the wheel over and over again, often in a slightly more unstable version.” – J.K. Galbraith

Earlier this week I set out to define ‘This time is different.’

It’s a tough one to explain considering markets are always different because they’re complex, adaptive systems. But it’s never different because human nature still leads to bad behavior at the worst possible times.

It’s a context dependent definition.

Another reason it’s always different is because collectively investors are becoming better, smarter and more informed. There’s more free information out there than ever before.  In the past, to receive annual financial statements for a company you would have had to send a request through the mail to get them mailed back to you.

The process could have taken over a week. Now you can access current and historical data anytime you want through the Internet. Today when a new data point or interesting piece of news comes out, within five minutes you can be sure that someone will dissect that information for you with a neat little summary on Twitter or through their blog.

It’s also much easier and cheaper to invest now than it was decades ago. Investment strategies that were once reserved for only elite hedge funds and pensions are now available in ETF form and tradable on stock exchanges throughout the day.

I came to realize how far we have come when I read Investing: The Last liberal Art by Robert Hagstrom (a great book about Charlie Munger’s mental models approach). Hagstrom discusses the origins of discounted cash flow analysis on stock prices, which occurred in the 1930s:

“(John Burr) Williams believed that prices in a financial market were merely a reflection of the asset’s value. Economics, not opinion. In making this statement, Williams turned attention away from the time series markets (technical analysis) and instead sought to measure the underlying components of asset value. Rather than forecasting stock prices, Williams proposed the value of any asset could be determined using the “evaluation by the rule of present worth.” In other words, the intrinsic value of a common stock, for example, is the present value of the future net cash flows earned over the life of the investment.”

On the first day of class in financial analysis 101, they teach you the value of any asset is the sum of all future cash flows discounted to the present value by a reasonable rate of interest. This simple concept that is now widely known and practiced by many fundamental investors (including Buffett) wasn’t being formally used or written about until the 1930s.

Basically investors just used past prices, trends and gut instincts to predict future stock moves (although many still do this). DCF isn’t a perfect model because it still requires investor assumptions (garbage in, garbage out, as with all models), but it nonetheless leads to a reasonable way to gauge future possibilities.

No model is precise, so a degree of accuracy or approximation is the best you can hope for with an uncertain future. It’s just amazing to think that 80 or so years ago there were theories being formed that today are fairly common knowledge in the industry and classroom.

My point here is that when someone tells you they have a can’t-miss investment system that has outperformed the market throughout history, you should be skeptical that they could have actually pulled it off in real-time.

It’s useful to remember how far we’ve come when thinking about the markets in a historical context, but also how different things are today than they were in the past. Markets change in many ways while humans nature is the constant.

Investing: The Last Liberal Art


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  1. JC @ Passive-Income-Pursuit commented on Jan 17

    In the long run prices will reflect the intrinsic value, but in the short term, who the hell knows. KO at 30+ EPS around 2000? Not very realistic. It’s pretty amazing though how the standard valuation techniques used now weren’t even around 80 years ago. I’ll be curious to see what kind of methods are thought up of and become common practice in the next decade or two.

    • Ben commented on Jan 17

      Yeah I was surprised with that one when I read it. I had no idea. The amount of information and computing power help immensely these days.