Gross domestic product is the heart and soul of economic analysis. A country's investment propositions live and die by this metric, but its creator never intended for it to become the macro monster it is today. Here's what you need to know about it.
GDP was first proposed by Simon Kuznets in a 1934 address to U.S. Congress. The calculation was meant to serve as a way to quantify a country's production of goods and services, and it's officially measured as:
GDP = consumption + investment + government spending + (exports - imports)
That's C+I+G+X-M, or "Sigixim," as my economics professor used to shout as he threatened to tattoo the equation onto the face of any failing student. But for all of GDP's fame, it has one major flaw.
Flow versus stock
GDP measures "flow," which is similar to a company's income statement. What it ignores is a country's "stock" -- the equivalent of a corporation's balance sheet. Consider the implications of an investing world that analyzed sales and profit but completely disregarded assets and liabilities. Early-stage growth stocks would be laughed off of Wall Street, corporations could pile on mountains of debt, and a bad quarter could destroy an otherwise solid company.
It's this very sort of flaw that defines an entire realm of investing. "Value" investing is nothing more than identifying worth where others don't, either by knowing something unique or by more accurately interpreting available information.
For a company like Weyerhauser , seasoned investors smirk at the idea of reviewing the company's balance sheet to analyze its assets. An outdated accounting gimmick allows the 100-year-old company to value land at its purchase price, no matter how much real-estate prices rise. With 5.7 million acres in 11 countries, Weyerhauser's worth is much greater than its books let on.
"Natural capital" is economists' newest lingo for what GDP lacks. It attempts to take into account all the value derived from the natural environment, which is currently considered infinite or ignored. Natural capital can account for clean air and other ecosystem services, but it also adds in the value of minerals and other natural resources a country controls.
It's not such a crazy idea when you consider the fact that energy companies have been accounting for natural capital for hundreds of years. An oil company's stock shoots up when it makes a find, even if the find hasn't earned a cent and has cost the company billions in exploration fees. Likewise, if an oil field is unexpectedly depleted (or, in BP's case, banned), the stock may suffer.
If you consider the prospect of the U.S.'s recent oil and natural-gas finds, natural capital could go a long way to quantifying the argument for America's rebound. According to a new report by the International Energy Agency, the U.S. is ramping up oil production and could be energy-independent by 2030. With infrastructure to back it up, that could mean big returns for companies like Kinder Morgan Energy Partners and Chesapeake Energy . Chesapeake currently values its evaluated properties at $51 billion, with another $15 billion in unevaluated land. Kinder Morgan can send America's new fuel through its 29,000 miles of pipeline to 180 different terminals.
But if assets like oil fields are added to GDP, it's only fair that liabilities are also included. That means environmental costs get clout, which could create new opportunities for utilities like NextEra Energy , Exelon , and Duke Energy to improve the value proposition of their renewable energy. Production tax credits are an imperfect and temporary boost for wind, and natural-capital calculations might be just what this sector needs to push its clean-energy portfolio. And if natural gas doesn't turn out to be as clean as folks think, wind and solar could be boosted even higher on the energy totem pole.
Foolish bottom line
For most investors, GDP is little more than a mirror image of the S&P 500 .
But for those who look beyond production highs and lows, country-level economic analysis can prove to be a long-term investor's ally. Assessing each country's natural capital can help you know today what will play out tomorrow. A company's balance sheet bleeds onto its income statement eventually, and countries are no different. Arm your investing analysis with this tool, and you'll be well on your way to a wiser, wealthier portfolio.
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The article Why Smart Investors Should Ignore GDP originally appeared on Fool.com.
Justin Loiseau has no positions in the stocks mentioned above. You can follow him on Twitter, @TMFJLo, and on Motley Fool CAPS, @TMFJLo.The Motley Fool owns shares of Weyerhaeuser Company. Motley Fool newsletter services recommend Exelon. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.