By Dr. Rikki Racela, WCI Columnist

As I was getting financially literate and learning about equities, I tried to wrap my head around the concepts of companies being growth vs. value and small vs. large and why a factor premium should exist in small cap value companies. Yes, there exists a plethora of complicated research delving into price to book, PE ratios, CAPM, etc., that is utilized by Fama and French to prove that the expected return in the small and value factors should outperform the broad market index. But I am a busy doc with two kids who barely has time to run to the bathroom, let alone delve into this esoteric finance stuff.

I don’t want to read in-depth about discounted cash flows, CAPM, etc. It seems just as complicated as solute shifts in renal tubules! Yet as an investor who wants to boost his investment return as much as possible, it is imperative that I understand the factors of small and value before I invest, right? So, in my naïve investing mind, I found a construct to help me understand equity factors. It starts with The Rock.

Yes, The Rock. You might be asking, “Rik, what the heck are you talking about?” To better understand the equity factors of growth, value, large, and small, I have used representative actors/actresses and their salaries as a proxy for stock price and eventual investment return in terms of how much money their films eventually bring in. I believe this easily grasped and kind-of-fun framework mirrors nicely how equity investing acts in the stock market, and it also provides insights into how these factor characteristics might pay a premium.

Let’s start with The Rock!

 

Large Cap Growth: The Rock

If there were an actor that represents a large growth stock, it would be The Rock. I mean, look at those muscles! His popularity nowadays is reflected by how much it costs to hire the man. In five out of the past six years, he has been the No. 1 or No. 2 highest-paid actor of the year, ranging from $60 million-$124 million per year. The one year he wasn’t in the top two, he was the fifth highest-paid actor at a measly $22.5 million. Not too shabby for an off-year. Despite the astronomical salary, it seems the movie studios’ investment in The Rock’s stock as an actor paid off handsomely. According to movieweb.com, The Rock’s films have brought in an incredulous gross of $12 billion. Hollywood’s investment in The Rock has earned a nice return, increasing the willingness of studios to pay his ever-increasing price.

However, like a growth stock, paying an actor like Dwayne Johnson could have a volatile payoff. One of his recent successful films, Furious 7, brought in a massive $1.5 billion. However, according to screenrant.com, his 2021 movie Jungle Cruise had a whopping budget of $200 million, but it only made $220.9 million by the end of its theatrical run. The Rock’s salary is more than the profit made from this movie. Now, I guess you can blame COVID for the poor performance of this movie, but that’s exactly the point of investing heavy money in The Rock as well as a growth stock; there are factors that might be out of anyone’s control to affect future investment returns.

Just like actors and movie profits, investing in a company’s stock works on a financial concept called the “discounting cash flow model.” Hollywood producers and casting directors have to look at The Rock’s asking price and see if it is worth the predicted future cash flow (movie profit) that the film will provide. And yes, we expect The Rock’s future cash flow to be a huge Hollywood payday.

Dwayne The Rock Johnson

Just like how hot The Rock is in Hollywood, Tesla is a company that has been hot in the stock market. Tesla is now a household name. But it wasn't always so sexy. A half-decade ago, Tesla’s share price was around $20, corresponding to The Rock being in the early part of his career as a former WWE wrestler and a beginner actor. Using our discounted cash flow model, hardly anybody would have expected huge profits from Tesla. But now Tesla’s stock price is around $175 (though it has been as high as $400+). That’s a 775% increase in the past five years.

Yes, just like The Rock being expected to produce even bigger and more profitable movies, some expect Tesla, through the discounted cash flow model, to produce huge profits despite the ever-increasing stock price. This is the definition of a growth stock! But a growth stock price can reflect more hype than the profit you would expect with a discounted cash flow model. Just like The Rock will, at times, have a box office bomb like Jungle Cruise, Tesla’s predicted future cash flows are, at times, questionable. Tesla only achieved profitability in 2020, and even then, it has only attained modest profits, as much as $12.5 billion in 2022. Even now, Tesla has been a disappointing performer in the S&P 500 in 2024. Unlike The Rock, Tesla might be over the hill and on the downslope.

Just like paying The Rock’s huge price tag in the hopes of big-time theatrical payoffs, buying Tesla’s expensive stock price now would lead you to hope for an immense gross in the future. And, without a doubt, it’s The Rock’s and Tesla’s potential in promising these huge paydays that drive their respective prices.

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Large Cap Value: Samuel L. Jackson

On the other end of the spectrum of growth are value companies, and I can think of no other actor that represents large value companies like Samuel L. Jackson. He’s been omnipresent in mainstream movies for years, from 1988’s Coming to America (the guy who held up McDowell’s) to Nick Fury in The Avengers. He starred in Pulp Fiction, wielded the Force in Star Wars Episodes I-III, led the ensemble in the Shaft remake, and took a mauling by dinosaurs in the original Jurassic Park. Now, hold onto your butts, but his movies overall have made $27.8 billion.

This is more than twice The Rock’s overall gross total in films. Yet how much does it cost to hire this actor? According to fandomwire.com, Jackson makes “only” $10 million-$20 million per year, still less than The Rock’s lowest payday of $22.5 million. Looking through the lens of how much it costs to hire the actor and how much money his films have raked in, Jackson looks like a bargain, aka a great “value” for how much he costs vs. the profit his services provide.

Applied to stocks, what I have just gone through is the actor version of “price to book,” one of the main metrics that defines what a value stock is. When it comes to a stock, you look at the price of the stock vs. how much a company is worth “in the books.” For example, let’s take the large cap value company Exxon, one of the original 30 companies of the Dow. The company stock currently sits at a price of about $110, while the book value of Exxon is around $450 billion. Contrast that to Tesla where the stock price again is currently around $175, but the overall book value of Tesla when I originally wrote this was estimated to be $105 billion. In terms of buying Tesla stock vs. Exxon, you would have been paying 60% more for a piece of a company that was 4x smaller! Talk about Exxon being a good “value” stock. Why is this so? Because Exxon is Samuel L. Jackson. Exxon isn’t sexy polluting the environment with its oil refineries and Exxon Valdez disasters. The company isn’t developing new, cool EV technology that we believe everybody will be driving around in the future. Instead, its product powers the old-school combustion engine that came about at the turn of the 19th century. Exxon, like Samuel L. Jackson, just isn’t in favor with stock investors, despite the huge overall worth of the company and the continued steady large streams of profit it has been generating for more than a century.

 

The next section of my comparison will feature actresses who represent small cap equities. Unfortunately, the gender income disparity is horribly magnified in Hollywood, which is why females represent the small cap group.

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Small Cap Growth: Jennifer Aniston

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Jennifer Aniston was a highly successful TV actress in Friends, but she's since moved over almost exclusively to film with high expectations and a high salary. For a while, she had quite a run of mainstream Hollywood movies, including a waitress in the cult classic Office Space, the love interest in Along Came Polly, and one of the horrible bosses in Horrible Bosses. In her latest film in 2023, Murder Mystery 2, she commanded a payday of $10 million. Hollywood movie companies pay her high price tag, but her movies have failed to produce any mega-blockbuster hits. Despite commanding a salary as high as Samuel L. Jackson’s, the gross return on Aniston's movies has only totaled around $2 billion, according to thenumbers.com.

Let’s compare her stats to a small cap growth company. I will choose a medically relevant company called Sarepta. Sarepta is a small pharmaceutical company on the cutting edge of gene therapy, having already developed a genetic-based product used for Duchenne Muscular Dystrophy (the drug is technically an oligonucleotide, which binds defective mRNA in order for a patient to translate more effective dystrophin protein). Sarepta’s stock price sits at around a lofty $125 a share, as of this writing. The company’s book value is only $700 million, so you have to pay a pretty high stock price for a piece of this tiny company. Compare this to the example of Exxon, where the stock price is similar at around $110 but the book value is $400 billion. According to stockanalysis.com, in the previous 12 months when I was writing this, the operating cash flow for Sarepta was -$433.57 million and the capital expenditures were -$34.76 million, giving a free cash flow of -$468.33 million. It’s losing money! You definitely are not getting great “value” when you purchase a share of Sarepta. What you are buying is the promise of huge profits and “growth” in the future, where the promise of genetic technology will heal and cure innumerable ills, followed by great profits.

Investors are enamored with Sarepta’s potentially huge future cash flows as per the discounted cash flow model, just like movie studios are enamored with Aniston’s profitable success in TV to possibly translate to the silver screen.

 

Small Cap Value: Brie Larson

You might be asking yourself, “Who?” And that is exactly why Brie Larson is an exemplary “small value” type actress. Her salary is a measly $2 million a movie on average, but her films overall have brought in a gross of $6.25 billion. The first I knew about her was acting as the love interest of Jonah Hill in 21 Jump Street, but she has had quite a career (and even won an Oscar for her performance in Room). To have this actress with that resume in your movies for 5x less than Jennifer Aniston is a true value. She is better known more recently for being Captain Marvel. Despite being paid more than twice as much at $5 million for that particular role, Captain Marvel raked in $1.3 billion. Incredible!

Compare Larson to a small cap value stock, Selective Insurance Group. Not chosen completely at random, Selective Insurance happens to be my auto insurance company. Its stock price is similar to Sarepta’s at $100 per share, yet the book value of the company is almost 15x more at $11 billion. According to macrotrend.net, Selective Insurance’s annual revenue for 2022 was $3.558 billion, a 5.29% increase from 2021. Not only did it actually make money compared to our small cap growth example, its profits are comparatively monstrous (and growing!). But why is Selective Insurance’s stock price not worth more than Sarepta’s? I think you know the answer to that. What sounds more impressive: the promise of curing previously incurable genetic diseases where millions of people are suffering and could potentially be helped and lives saved, or car insurance?

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Understanding the Value Premium Through Our Thespians

Now we can understand why there is a value premium in equities when using our comparison with actors. Again, The Rock has the smile, the muscles, and the ability to beat up bad guys. He is everything Hollywood wants, and he embodies the formula for huge profits in movies. You can’t go wrong hiring The Rock. In a sense, there is more risk in hiring Samuel L. Jackson because he doesn’t fit the Hollywood formula of a huge profitable leading man. Jackson is more risky in that sense where his quirkier roles don't guarantee hit movies. The same goes with Jennifer Aniston, who has proven profits and audience appeal through her role in Friends. She is not as risky casting as a leading lady vs. Brie Larson, who is more relatively unknown and unproven, at least on a larger stage. Brie Larson commands more risk. As these value thespians have more risk, their commensurate salaries are lower, but their payoff can be just as much or can exceed their growth counterparts.

The other half of the value premium is a behavior story. Again, rugged good looks and large biceps are traits humans always admire and that some ladies drool over, exemplified by The Rock. Behaviorally, there will be fewer women pawing for pictures with Samuel L. Jackson compared to Dwayne Johnson, and most males, like myself, work out in the gym to look more like Johnson, not Jackson. Another human trait that we behaviorally have is the imagination and optimistic possibilities that Tesla and Sarepta demonstrate. We will pay more for the promise of better and cleaner electric cars or to cure previously incurable genetic diseases vs. investing in dirty old polluting oil or annoying car insurance companies. Through the lens of Hollywood actors and actresses and their respective salaries and box office profits, we can understand the risk and behavior characteristics that embody the value factor premium.

The risk and behavior story applies to our “small” actresses as well, where Brie Larson is not as well-known as The Rock or Samuel L. Jackson. Any movie she is in will have more risk given she is not a household name and may not attract big-time crowds in theaters.

You don’t need to read Fama and French’s seminal papers regarding factor investing to understand factor premiums. Instead, just head to your nearest AMC or turn on your streaming service. The factor premiums are a reflection of risk and behavior that pervades any type of economic calculation, whether it’s investing in company stock or paying the salary of your actors/actresses.

There's no need to be intimidated by factor investing; as long as we have been watching movies, we inherently know how factor premiums work.

 

Physicians train for years to learn about medicine. But financial literacy was not part of the curriculum. That’s where The White Coat Investor comes in—by offering tons of entry-level information to get you started on the right path. We have a FREE email series called WCI 101 that reviews the basics in bite-sized chunks. You can check out our Start Here page to learn all about personal finance for doctors. And you can peruse our Frequently Asked Questions to get even more info. It’s easy to feel overwhelmed when learning about finance. WCI is here to help!

 

What do you think? Do you think the analogy of equity factors and actors/actresses makes sense? Do you think this really helps in understanding factor premiums and the discounted cash flow model? Or do you think I am just some silly neurologist who watches too many movies? Comment below!