Investing Together: Applying the Principles of Value Investing to the Private Market

“In the short run, the market is a voting machine but in the long run it is a weighing machine” Benjamin Graham

If you’ve been an active investor and student of the greats it’s likely you’ve come across Benjamin Graham. His impact on the world of investing cannot be understated. Known informally as the father of value investing, there are many quotes, accolades and accomplishments attributed to him and his seminal work in the area. Arguably his most famous work, a book titled “The Intelligent Investor,” has remained a go-to resource for investors since 1949.

So what exactly is value investing? And why has it dominated the investing narrative for so long?

Graham’s theory is fairly straightforward, but there is genius in its simplicity. The aforementioned quote serves as a cornerstone for his thesis: in the short run, markets are a voting machine, in the long run they become a weighing machine. In the near term, markets act as a voting mechanism for companies, which is to say that investors buy and sell stocks based on feeling as opposed to logic. Hype, fads, bubbles, trends and groupthink all play into this short run game in the markets (the Gamestop & AMC memestock debacle is a recent, yet extreme example of this) . Value investors, on the other hand, take a long-term outlook – favoring business fundamentals and portfolio diversification instead of trading on a whim for quick profits. The weighing machine represents those very fundamentals that indicate the true value of a company. If you weigh correctly, identify a price, purchase below that price and hold your position, the theory states you will win out in the long run.

Sounds easy, right? Nevertheless, it comes down to a question of focus and fundamentals. Graham outlined 5 key metrics necessary to estimate the real value of a business:

1. Capitalization Factor (long-term growth horizon)
2. Management Quality
3. Financial Strength and Capital Structure
4. Dividend Record
5. Current Dividend Rate

Evaluating these metrics for publicly traded companies is possible because they are forced to publish cash flow statements and EBITDA by agencies like the SEC (in the US). But how exactly do we apply the principles of value investing to the private markets? That becomes much harder for several reasons, but cracking the code on this conundrum can unlock tremendous, untapped value for private market investors.

Private markets certainly aren’t immune to the perils of social psychology, but its relatively small scale and limited access to investment drastically changes the dynamics. In the past couple of years we’ve seen a tradeoff between business fundamentals in exchange for relentless growth. WeWork’s fall from grace, an explosion (and implosion) of 15-minute delivery services, crypto volatility, massive losses from prominent funds like Softbank – but generally speaking, early stage venture capital is a long-term approach with a bit of extra risk. The extra risk factor leads to portfolio diversification while the promises of the Power Law compensate for said risk. Ultimately, private markets tilt heavily towards the voting machine, but not for lack of trying.

Weighing (measuring) the value of private companies is hard because often they are pre-revenue, even pre-product. Investing in visionaries typically requires imagination around a new product category or market that doesn’t yet exist. Much of the data you ordinarily find on public companies either doesn’t exist on the private side or remains hidden in the heads of founders, investors or pitch decks. So how do we pivot from a private market voting machine to a weighing machine? In other words, how do you embed value investing principles into private investing without succumbing to the perils of social psychology and bad information?

We posit that this can be done with a community-first private investing platform.

To be clear, early stage investors do apply value judgements to the companies they invest in to the best of their ability. Industry benchmarks and the latest revenue multiples behave as a proxy for expected value. Telling a story around the equity of your company, however, is largely responsible for early confidence, fundraising and implicit potential. The path to a more measured approach to private investing lies in the people that make up the private market.

We believe the analog to public market data and analyses is the community of investors that back a deal. Syndicate leaders and experienced business angels have a wealth of data, the problem is it can be hard to extract. It doesn’t always sit in spreadsheets and it isn’t usually accessible via API. The value investing equivalent for private markets is the community of investors pooling their capital, expertise and network to identify, fund and manage top-tier investments. It’s hard to identify signals through the noise, especially if the underlying data isn’t available. We imagine a world where private investors can curate and manage their very own “braintrust” within Roundtable and start weighing the early stage markets accurately to unlock outsized impact and returns.

Are you a business angel or syndicate leader looking to build your very own private investing community?

Sign up for early access to Roundtable here!