Crossroads Capital’s commentary for the month of July 2025, title, “What is Value?”
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How we think about valuation
Over the last few months, as we have discussed what we believe are our most promising investment opportunities with prospects, a common refrain early on has been something like this: “But that’s not a value stock. I thought you were value investors!” While at times these conversations have been frustrating, we realize the burden of articulating why we believe a particular investment represents mispriced value falls squarely with us. Rather than go into the specifics of one of the names in our portfolio that seems to be generating this friction the most, we felt it would be better to start with a broader problem: Nobody agrees on what “value” means. So, what is value – and “value investing” more generally?
The textbook definition of valuation – estimating the present value of future cash flows – is analytically sound, but philosophically thin. It implies scientific precision where none exists. Yes, businesses have intrinsic value, which is nothing more and nothing less than the sum of expected future cash flows properly discounted for risk. And yes, determining this intrinsic value is the fundamental building block of all sound investment decisions and indisputably the “North Star” of successful portfolio management. However, intrinsic value is not directly measurable or inherently observable, can be difficult to quantify, and constantly changes with new information. In other words, exceptional valuation work, like all sound decision-making, requires superior judgment. This is simple to understand, but not easy. Exactly like value investing is supposed to be.
In today’s investing landscape, the label “value investor” is often shorthand for a rigid adherence to low multiples based on backward-looking screens built on GAAP financial statements. That’s not our philosophy. While we care deeply about cash flows, we recognize that value often hides in places traditional frameworks overlook: emerging business models, misunderstood growth, or unrecognized shifts in quality that can’t be quantified or properly understood by combing through past financials. In fact, we’ve routinely invested in companies that appeared expensive by conventional metrics in relation to their past performance, but were nevertheless profoundly mispriced. Nor do we confine ourselves to outdated Fama-French-inspired heuristics in our hunt for value, choosing instead a broader, more dynamic view of valuation. Our view reflects both analytical rigor and contextual insight in pursuit of the most important thing: figuring out what a business is worth and paying a lot less. hat’s value investing, properly defined.
It’s also worth pointing out that Crossroads stands with the lion’s share of history’s great investors when we unequivocally state that we couldn’t care less what a business earned in net income last year, or whether it’s statistically cheap on conventional accounting metrics. The real question is whether it’s cheap relative to its medium-term earnings power. The goal is simply to determine the true cash-generating power of a business or asset without hurting its ability to compete or maintain itself, rather than getting distracted by accounting numbers
that may or may not reflect economic reality (or miss the point entirely). As Warren Buffett reminds us, the investor of today does not profit from yesterday’s growth. As a case in point (out of countless examples), we’ve watched Amazon increase in value more than 100x despite appearing “expensive” on a GAAP earnings basis the entire time. The constant refrain from so-called “value investors” was, “Wait, doesn’t Amazon trade at 95x earnings?” The key point then, as now, was simply that Amazon’s net income was never reflective of its true earnings power – and therefore shouldn’t be the primary metric used to value it. That’s just common sense, so we’ll spare you a long treatise on why. As Jeff Bezos told his shareholders in Amazon’s 1997 annual letter, “When forced to choose between optimizing the appearance of our GAAP accounting and maximizing the present value of future cash flows, we’ll take the cash flows.” So will we, Jeff, every time.
With that, let’s start our valuation discussion at the beginning by looking at cash flow.
Cash Flow-Centric Analysis – The How and When Determine the Way Forward
We believe a company’s worth is fundamentally tied to its ability to produce cash for its owners over time. However, not all cash flows are created equal. Some businesses generate consistent, growing streams of cash over long periods, driven by durable competitive advantages and secular trends. Others offer cash flow potential tied to specific near-term events or strategic shifts that can dramatically alter a business’s trajectory – and, as a result, the market’s present view of its intrinsic value. Recognizing this distinction, we’ve developed two distinct lenses through which we assess value in a more enlightened way, detecting the full spectrum of opportunities while maintaining a disciplined focus on cash flow and downside protection.
Emerging Compounders: Valuation as Forward-Looking Business Analysis, Not Backward-Looking Accounting
Our first value lens helps us identify and own the next great growth business before it’s widely understood and, therefore, priced as one. We call them “emerging compounders” – our term for any relatively new and underappreciated business, either standalone or nested within a larger company, with durable competitive advantages, secular tailwinds, and a long runway for high-return reinvestment that enables sustained cash flow growth. (These elements could more easily be described as the enduring characteristics of great businesses.) Valuing emerging compounders is a forward-looking act of business analysis, not a mechanical exercise of applying multiples to revenue and margins very similar to what the company produced over the most recent trailing twelve months. In other words, to correctly assess the value of a company like Amazon (to use our prior example), an investor must look beyond current net income figures and think ahead to where the company will be several years down the line.
How does one attempt to see into the future? Rather than rely on crude heuristics or superficial peer comps, we use a first-principles DCF framework. But the purpose isn’t to reverse-engineer a justification for current prices (although that’s helpful as far as it goes); it’s to isolate normalized earnings power several years out, based on a deep understanding of how the business will operate, improve, and scale over time.
Take R1 RCM, a healthcare revenue cycle platform, an investment of ours from 2016 to 2024. If we had looked only at its then-current cash flow or earnings, we couldn’t possibly have concluded the company was undervalued. However, we saw how R1’s automation improved hospital margins. We dug into how existing contracts ramped from negative to highly positive cash flow within 12 to 18 months. And we modeled its forward cash flows for the next several years as (in our view) revenue would grow and margins would inevitably expand. As a bonus, our analysis of the healthcare IT outsourcing industry revealed that longstanding trends towards outsourced revenue cycle solutions among major hospital networks were poised to accelerate, adding an external tailwind to R1’s already underappreciated operating momentum and the idiosyncratic factors propelling it. Looking beyond the next 12 months, we saw a high-quality business with sticky, contracted revenues and expanding margins, run by a management team deploying a unique business model in a large, growing niche within the resilient and highly defensive healthcare industry. To use a hockey analogy, we focused not on where the puck was, but on where it was going to be – and that made all the difference, as it has so many times since we launched Crossroads nearly a decade ago.
When we first started looking at R1, it was not an obvious winner. Its financials seemed poor, there were concerns over management’s go-forward strategy and the fallout from a regulatory snafu, and its TTM valuation multiples were highly elevated. On the other hand, modeling a few possible future scenarios that incorporated our differentiated views pointed to upside in just about every case. All the company had to do was execute. In time, R1 onboarded an anchor customer and executed moderately well over the years, and the market quickly came around to agree with our initial view.
So in contrast to “value investors” who avoid businesses trading at high earnings ratios, we often find the best risk-adjusted returns where current circumstances obscure economic reality, and in particular the timing and strength of a company’s ability to generate cash for its owners. In other words, the best valuation work isn’t about what looks cheap now; it’s about what become obvious later. Of course, that’s easier said than done. Management could fail to execute. Tailwinds can change. Other lines of business sometimes drag down the whole. Or an investment’s cash flows just might not be as sustainable as we thought. In those situations, we try to exit our position swiftly and, we hope, with minimal losses. And that’s okay. Not everything turns out like R1, but we don’t need to be right every time. We just need to make more when we’re right than we lose when we’re wrong.
That’s easier than being right all the time, but still harder than it might seem. It requires us to try to overcome the natural human tendency to prefer low prices to high ones, because seeing the true intrinsic value of certain companies requires looking beyond this year’s price-to-earnings or price-to-book ratios. As another example, consider Walmart. During its growth phase in the 70s and 80s, Walmart never appeared statistically cheap. Yet in hindsight, it was clearly undervalued for most of that period and ended up as one of the best-performing stocks of all time. Exploiting this difference between optics and economic reality on our investors’ behalf is, quite literally, our sacred duty. Our job as stewards of our collective hard-earned capital is to see reality as it is, rather than as we wish it would be. If doing that well forces us to endure long periods of being misunderstood by those with only a superficial grasp of what it takes to be a Hall-of-Fame bargain hunter, so be it.
Special Situations: Company with Options-Like Opportunities, Both for Cash Flow and Equity Returns
Our second value lens is built to detect special situations. It lets us consider value that could result from strategic optionality or definitive external events, instead of estimating how a business will evolve over the longer term. Think of special situations as shorter-duration, event-driven bets with asymmetric payoff profiles. They’re cases in which the market has priced in the status quo continuing into perpetuity, but value-unlocking change is afoot.
Here, a DCF framework can fall short. In most such cases, we apply a real options lens – not just valuing a company as it stands today, but also considering the valuation impact of specific events by trying to model their rough cash flow impact. We creatively map out a wide range of scenarios, apply probabilities to each, and discount cash flows based on our investigative work. It’s a method for quantifying latent value embedded in corporate restructurings, strategic investments, regulatory decisions, competitive realignments, and other one-off occurrences.
Consider Magnite (NASDAQ:MGNI), the leading independent sell-side ad tech platform. On the surface, MGNI is a cashgenerating SSP with moderate market share. But embedded within it is a high-volatility option on structural change: the DOJ’s antitrust case against Google. If the outcome restricts Google’s sell-side dominance, MGNI stands to benefit from a large-scale reallocation of auction volume.
We considered how Google’s market share loss might vary depending on the extent of the remedies ordered by the court – ranging from simple fines to behavioral remedies to divestiture of entire business lines. Then we modeled outcomes for each scenario in terms of cash flows over time, discounted back to the present, and assigned probabilities to them. (In Magnite’s case, this step seemed almost superfluous because we felt it was quite clear that even the mildest adverse impact on Google would massively benefit Magnite.) As in most cases, we then finalized the analysis by assessing the “premium” we would pay to own the optionality in question. For the equity, we look at the capital cost and time decay for the company, and how much of a benefit is built into consensus expectations. For investing in the real option via equity options, we of course look at the implied volatility and time decay against the expected event path for the company.
In the end, we felt that the real option premium was practically zero for Magnite’s equity and only modest for the options, which had slightly elevated volatility compared to past levels. (This increased volatility could easily have resulted from the trade war concerns in the news when we updated our antitrust thesis this past May.) The key point for us was that Magnite exhibited a call-like option on its cash flow profile, and in the equity market that option was being valued at basically zero despite possible outcomes pointing to a possible 5-10x return. And by our measure, those outcomes were not just possible but probable. You can read our full MGNI and Google Antitrust update here. This is our kind of bet, to be sure.
Looking at special situations that have discontinuous impacts on a business and its equity necessitates, in our view, a real option framework – one in which outcomes are binary but have a branching event path, are timingsensitive, and are vastly mispriced by conventional investors using single-view DCFs or rules of thumb.
Conclusion
Valuation is not a formula, it’s a framework. And like any robust framework, it must adapt to context, evolve with insight, and remain grounded in reality without being bound by convention. At Crossroads, we don’t seek value in the rearview mirror; we look for it where others aren’t yet paying attention. Whether it’s the long arc of compounding cash flows in an underappreciated business or the sharp asymmetry of a special situation catalyzed by a definable event, we aim to value what the market will come to understand, not what it already knows. Our discipline lies in the rigor of our analysis and the creativity of our perspective.
In a world increasingly driven by complexity, speed, and noise rather than signal, rest assured our edge doesn’t come from purchasing statistically cheap so-called “value stocks” from a recent 52-week low list. It comes from knowing where to look for opportunity and being as close to right as we can be about what a business will earn and the multiple the market will eventually place on those earnings. Good valuation work isn’t about being precise; it’s about being directionally correct when and where it matters most. After all, being able to exactly measure value is far less important than being able to find it in the first place.
As always, feel free to reach out to discuss our valuation framework.
Sincerely,
Ryan O’Connor
Founder and Portfolio Manager
Daniel Prather, CFA
Director of Research