Mr. Buffett always starts with the balance sheet. That’s the foundation of the analysis.
If the balance sheet shows a lot of assets, but those assets generate a low return or are not being used productively, then what you would expect is for the company to trade below balance sheet value. Or, at the very least, you use the balance sheet to evaluate the capital employed.
Now, this is not perfect. In fact, it’s imperfect.
There are many assets that do not properly appear on the balance sheet: customer lists, anti-competitive business models, monopolistic positioning, network effects, and things like that. On the other hand, you may also have assets that are outdated or obsolete.
When the assets are obsolete, what you often find is that the market decides the company would be better off liquidated. In those situations, enterprise value can trade below the reported asset valuation. That’s where you sometimes find interesting going-out-of-business or deep value situations — companies trading below what the balance sheet says they are worth.
But the opposite also happens.
When you have extraordinary business models, extraordinary moats, or anti-competitive businesses, the market value of those assets can be dramatically higher than what is reported on the balance sheet. A monopoly or duopoly does not properly show up in accounting statements, yet those characteristics can make a business enormously valuable.
As a result, the company becomes worth far more than its reported book value.
And this is a critical exercise that most analysts do not do:
Is the business truly so extraordinary, so special, that it can continue to grow with minimal capital expenditure because competition is limited? If so, then perhaps it is logical for the assets to trade at a very high multiple to balance sheet value.
But here is where things become interesting.
Today, you have many companies trading at extraordinary premiums to their capital employed — and balance sheet value is an imperfect but still useful proxy for that capital employed.
The question is: can everybody really be extraordinary?
They cannot.
You can have a few of the Magnificent 7 companies with genuine competitive advantages. Some of them truly have dominant positions. One of them, in fact, has almost no meaningful competition in its core business.
I’ll let you decide which one.
Others, however, face enormous competition. Tesla is the obvious example. The car business is cutthroat. Competition is relentless. And over time, we will get deeper into issues such as next-generation batteries, solid-state technology, and which companies actually have a game there and which do not.
Meanwhile, many smaller companies — including some in the space industry — are trading at extraordinary premiums relative to their capital employed.
At some point, you have to ask whether the market is assuming too many companies possess exceptional economics at the same time.
Everybody cannot be extraordinary.
And from there, you have to come to your own conclusions.
Fudge the Absurd — And LLMs Falling Into the Same Human Trap
What I have also noticed recently is the tendency to fudge the absurd.
Humans are so uncomfortable with absurdity, so uncomfortaable that the world can irrational, unstable, absurd, completely random that they automatically manufacture explanations to avoid admitting something may simply not make sense. And yet history gives us endless examples.
There have been mass suicides because of religious hysteria. There have been genocides because of political brainwashing. There have been speculative bubbles in assets as ridiculous as tulips or Beanie Babies.
So there is plenty of historical evidence that markets, societies, and human beings do not necessarily behave rationally.
But what is interesting now is that this tendency is increasingly being copied by LLMs.
You ask a simple question:
How can this asset be valued at such an extraordinary level if the business faces enormous competition?
And instead of first examining the contradiction, the response often immediately becomes:
“The reason why is…”
And then comes the rationalization.
In other words, instead of putting the pieces together and admitting that the situation may simply not make sense, there is an automatic impulse to preserve coherence.
The absurd must be explained away.
The contradiction must be softened.
The cognitive dissonance must disappear.
What is fascinating is that this appears to be deeply human behavior — and now LLMs are inheriting the same flaw because they are trained on human responses and human preferences.
This does not mean markets are always wrong. Some businesses genuinely are extraordinary.
But the process is inverted, it starts by removing the absurd instead of embracing it.
But if you are a bit like Lewis Carroll, perhaps you actually enjoy absurdity.
If you refuse to fudge absurdity — and history gives us endless proof of absurdity — then you end up living in a world where you are surrounded by irrationality and it can be draining at times.
You end up laughing nervously in a high pitch while reading financial statements and market narratives, while your partner looks at you bizarrely, wondering whether you are slightly deranged.
Because, mentally, you already live on the other side of the mirror.
Laugh or cry, your choice.