Lesson 5 of 8
The Columbia line
Graham asked what the assets cover, Buffett what the business earns on them, Greenwald what a competitor would have to spend to reproduce them.
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.
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In one minute
- Greenwald's framework ranks three estimates by how reliable each one is: asset value first, earnings power value second, the value of growth last.
- Asset value here is reproduction cost, what a competitor would have to spend today, rather than book value or liquidation value.
- Growth creates value only inside a barrier to entry, which is why it sits last and is the tier most often assumed rather than shown.
Each generation in this line kept the previous question and added one. The additions are cumulative rather than corrective, and the last of them turns the whole thing into a test you can fail.
Three estimates, ordered by how much has to be assumed
| Order | The estimate | What it rests on |
|---|---|---|
| 1, most reliable | Asset value at reproduction cost | What a competitor would spend to build the same asset base today |
| 2 | Earnings power value | Normalised current earnings capitalised at the cost of capital, with no growth assumed |
| 3, least reliable | The value of growth | Worth nothing unless a barrier stops competitors taking it |
Reproduction cost, not book and not liquidation
Book value is a history of prices paid. Liquidation value is what a forced seller receives. Neither answers the question a competitor is actually asking, which is what it would cost to assemble this asset base from scratch today in order to compete.
That is the number Greenwald's first tier uses, and it changes what belongs in it. Spending that built a customer base or a product, expensed as incurred and therefore absent from the balance sheet, is part of what a competitor would have to spend, so it is part of reproduction cost.
Earnings power value is deliberately growth-free
The second tier capitalises normalised, sustainable, distributable earnings at the cost of capital and assumes no growth at all. That is not pessimism. It is a design choice about what the estimate depends on.
A discounted cash flow needs a forecast for every year of the forecast period. Earnings power value needs one number, this year's normalised earnings, and one rate. Fewer inputs means fewer places for an assumption to hide, and it means two people who disagree can find the exact line they disagree on.
The test the two tiers make together
The interesting move is comparing them. If earnings power value sits materially above reproduction cost, the business earns more than the cost of the assets it uses. That gap is an invitation: any competitor can see it, and building the assets would buy them the same earnings.
So the gap must be explained by a barrier to entry, or it will not persist. This is the franchise test, and it is the point where a valuation framework turns into a question about competition. Course V10 is that question worked out in detail.
Why growth sits last
Growth inside a business with no barrier earns the cost of capital, because competitors will enter until it does. Value is created by growth only where something stops them. That is why the third tier is both the largest number in most published valuations and the one with the least support under it.
What each generation added
Graham asked what the assets cover, and answered it from one statement. Buffett asked what the business earns on those assets and whether that will last, which needs a judgement no statement contains. Greenwald asked what a competitor would have to spend, which turns the judgement into a comparison between two computed numbers.
None of the three replaced the one before it. The Columbia line is a sequence of additions, and the 1984 essay Buffett wrote for the school's magazine is the document that treats it as a lineage at all.
Check yourself
What does Greenwald's first tier value the assets at?
- Book value from the balance sheet
- Reproduction cost: what a competitor would have to spend to build the same asset base today
- Liquidation value in a forced sale
Show the answer
Answer: B.
Reproduction cost answers the competitor's question. Book value is a record of past prices and liquidation value is what a forced seller receives.Why does earnings power value assume no growth?
- Because growth is usually negative
- To keep the estimate resting on one normalised earnings figure and one rate, rather than on a forecast for every year
- Because growth cannot be measured from filings
Show the answer
Answer: B.
Fewer inputs means fewer hidden assumptions, and two people who disagree can identify the exact input they disagree about.Earnings power value sits well above reproduction cost. What does the framework require next?
- Raising the growth rate to match
- Naming the barrier to entry that stops a competitor spending the reproduction cost to obtain the same earnings
- Nothing: the gap is the answer
Show the answer
Answer: B.
The gap is an invitation to competitors. It persists only behind a barrier, and the framework makes you name one.Sources
- Greenwald, Kahn, Sonkin and van Biema, Value Investing: From Graham to Buffett and Beyond, 2001: the three-tier framework, asset reproduction cost, earnings power value, the franchise test, and growth creating value only behind a barrier.
- Buffett, "The Superinvestors of Graham-and-Doddsville," Hermes, Columbia Business School, 1984.
What this leaves out
- The figure ranks the estimates by how much has to be assumed, not by size. The worked example uses invented round numbers and is labelled illustrative.
- Reproduction cost is an estimate that requires judgement about which expensed spending a competitor would have to repeat. This lesson does not settle that.
- Nothing here is advice about any security.