Lesson 6 of 7
Greenwald: value in three layers
Stack Greenwald's three layers of value and read the gaps between them as statements about barriers to entry.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- Greenwald stacks value in three layers, most reliable first: asset value, earnings power value on top of it, and growth value on top of that.
- Each layer above asset value survives only if a barrier to entry protects it, since competition erodes the gap without one.
- The size of each gap is itself a finding: how big a moat's earnings premium is, and whether that moat scales with growth.
Bruce Greenwald's method values a business in three layers, built one on another, rather than in one discounted cash flow. Each layer answers a narrower question than the one below it, and each one depends on the layer below already holding up.
Three layers, one company
Total value, if a barrier protects the business
- Growth value adds · only if a barrier holds$200m18%
- Earnings power value adds · the franchise premium$300m27%
- Asset value · reproduction cost$600m55%
Reproduction cost of the assets alone
Total$1,100m
The three layers, in order
Asset value is the reproduction cost of what a competitor would have to build to enter and compete, for a business in an industry worth entering, not the liquidation value of what already exists. The three layers run from most reliable to least, and asset value is the most reliable of the three.
Earnings power value capitalises current, normalised earnings at the cost of capital, assuming no growth at all. Where it lands above asset value, the gap is the franchise premium, the value of an advantage that lets the business out-earn what a new entrant, building the same assets from scratch, could expect to earn.
Growth value is added last, and is the hardest of the three to estimate. It only means something once the first two layers are in place.
Why growth needs a barrier to be worth anything
Greenwald's central claim about growth is the one that surprises readers most: growth adds value only where a barrier to entry protects the business earning it. In a business with no such barrier, growth invites competitors to chase the same demand, and the extra capacity they bring competes away the very returns the growth was supposed to capture. Growth there adds no value, even while revenue and earnings both rise.
A related point, made in general finance rather than by Greenwald himself, goes further: growth funded at a return below the cost of the capital it consumes destroys value outright. Buffett's 1992 letter makes this case, that growth is an input to a valuation, not a separate merit of its own.
Reading the gaps
The gap between earnings power value and asset value measures how much of an edge the business currently holds. The gap between the growth layer and zero measures whether that edge extends to whatever the company builds next. A company can show a wide first gap and a thin second one: a strong position in its existing market that a barrier does not protect once it expands beyond it. Reading the two gaps together says more than either number does alone, because a business can be defensible where it already sits and exposed everywhere it wants to go next.
Check yourself
In Greenwald's method, what does asset value represent?
- What the business would fetch in a fire-sale liquidation
- The reproduction cost of the assets a competitor would need to enter and compete
- The book value of equity on the balance sheet
Show the answer
Answer: B.
Asset value is a reproduction-cost estimate, what building an equivalent competitor from scratch would take, not a liquidation or book figure, for a business in an industry worth entering.What does a gap between earnings power value and asset value indicate?
- An accounting error
- A franchise premium, the value of an advantage over a new entrant
- A mistake in the reported figures
Show the answer
Answer: B.
Where earnings power value sits above asset value, the gap is the earnings advantage a barrier to entry protects.Under Greenwald's argument, what happens to the growth layer in a business with no barrier to entry?
- It grows larger, since more revenue always adds value
- It shrinks toward nothing, because competitors compete away the returns growth was meant to capture
- It is unaffected by whether a barrier exists
Show the answer
Answer: B.
Without a barrier, new capacity drawn in by growth competes away the advantage, so growth stops adding value.Sources
- Greenwald, Kahn, Sonkin and van Biema, Value Investing: From Graham to Buffett and Beyond, 2001: asset value, earnings power value and the franchise test.
- Greenwald and Kahn, Competition Demystified, 2005: barriers to entry, customer captivity and economies of scale.
- Berkshire Hathaway shareholder letter, 1992: growth as an input to value, not a separate merit.
What this leaves out
- The company and both scenarios in the worked example are illustrative, not any filed company's figures.
- Estimating a reproduction cost for asset value is itself a judgement, particularly for intangible-heavy businesses where little of the asset base is a physical thing to rebuild.
- Whether a barrier to entry actually holds is a qualitative call this page does not make for any company.
- Nothing here is advice about any security.