In 2012 Robert Novy-Marx wrote the paper The Other Side of Value:The Gross Profitability Premium. You could say that it is an attempt to test the hypothesis of Charles Munger and Warren Buffett that it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. Novy-Marx measures profitability by using a ratio of gross profit to assets. Efficiency ratios such as the Du Pont analysis (asset turnover x profit) have been used for a long time in finance and accounting, but the unconventionality of his approach is by only using the cost of goods sold and disregarding other costs.
Looking at NYSE firms between 1963 and 2010 and international firms between 1990 and 2009 (ex-financials), Novy-Marx discovered that a company’s gross profitability did as good a job at predicting its future returns as conventional value metrics like book-to-market. More profitable companies today tend to be more profitable companies tomorrow. Although it gets reflected in their future stock prices, the market systematically underestimates this today, making their shares a relative bargain – diamonds in the rough.
– The Mysterious Factor ‘P’: Charlie Munger, Robert Novy-Marx And The Profitability Factor from Forbes (June, 2013)
This is a dossier with resources and material regarding the valuation of defined benefit pension plans.
This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research
Pension Plan Calculator (spreadsheet provided by aliactuary.com)
Actuarial Methods and Assumptions used in the Valuation of Retirement Benefits in the EU and other European countries
Defined benefit audit techniques –
Robert Meegan (Northeast) a
Dave Harstein (Northeast), and Donna Prestia (CE&O), Reviewers
Stress Tests for Defined Benefit Pension Plans – A Primer – Gregorio Impavido
An Economist article on US public pension plans – Buttonwood
“Final salary pensions are a debt-like obligation, particularly in the public sector where the rights of pensioners are established in law (and even the constitution) in some states; there is an interesting case going on in Stockton, California, which may set the rights of creditors against those of pensioners. On corporate balance sheets, pension liabilities are discounted with a corporate bond yield. Falling bond yields have pushed up liabilities and widened deficits; hence many corporates have switched to defined contribution schemes. (Of course, the problem of low returns and falling rates dogs those schemes too, and are made worse by the low level of contributions that are made.)
This is NOT just a theoretical issue. If a company wants to offload its pension promise, or an individual wants to secure his pension by buying a fixed annuity, they find the cost has risen substantially.
But this doesn’t show up in the public sector. It uses the expected rate of return to discount its liabilities; since the expected rate of return is higher (7.5-8% is standard) than bond yields, it makes the liabilities look smaller, and reduces the apparent cost to taxpayers. The rationale for this approach is that pension funds can afford to take a long-term view and benefit from the returns on risky assets; contributions can be smoothed over the long term, avoiding any sudden jumps in employer (taxpayer) payments.”
A mental model is an explanation of a thought process about how something works in the real world. Mental models help shape our behaviour and define our approach to solving problems (akin to a personal algorithm) and carrying out tasks. Mental models have been studied by cognitive scientists as part of efforts to understand how humans know, perceive, make decisions, and construct behavior in a variety of environments. Charles Munger provides a concept of “Elementary, Worldly Wisdom” which consists of a set of mental models framed as a solving problems of business, finance and investing. According to Munger, only 80 or 90 important models will carry about 90% of the freight in making you a worldly-wise person.
Articles on Accounting as a Mental Model for Investing
Accounting Nuggets on Sportgamma
“Warren Buffett and Accounting in Favor of Investors” by Calvin Johnson
“To Catch a Thief: Can Forensic Accounting Help Predict Stock Returns?” by Messod Daniel Beneish, Craig Nichols and Charles M.C. Lee
“Tutorial to Quickly Detect Changes in the Footnotes” by Jae Jun at OldSchoolValue.com
“Ownership Changes and Their Impact on Net Operating Losses: Tough to Avoid and Hard to Control” by Peter J. Ulrich at Gibbons Law