Activist investors and contrarians battle for control of losing corporations by identifying undervalued companies trading well below their intrinsic value. The document discusses five main ideas: 1) Deep value strategies like contrarian investing outperform growth and quality factors. 2) Contrarians can identify mispriced stocks by going against the crowd. 3) Simple valuation models often outperform experts who overthink things. 4) The acquirer's multiple, which values companies based on earnings, is a straightforward valuation method. 5) Hedging strategies using indicators like moving averages can help reduce downside when the market declines.
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Deep Value and the Aquirer's Multiple by Tobias Carlisle for QuantCon 2016
1. Why Activist Investors and Other Contrarians
Battle for Control of Losing Corporations
DEEP VALUE
4. Five Ideas
1. The Deep Value Manifesto
2. Contrarians at the Gate
3. Simple, But Not Easy
4. The Acquirer’s Multiple®
5. Hedging Signals
5. Part 1. The Deep Value Manifesto
“Corporate gold dollars are now
available at 50 cents or less—but
they do have strings attached.”
—Benjamin Graham (1932)
6. Theory of Investment Value
“The value of any stock, bond,
or business today is determined
by the cash inflows and
outflows—discounted at the
appropriate rate—that can be
expected to occur during the
remaining life of the asset.”
—Buffett quoting John Burr
Williams (1938)
7. Value > Glamour
Source: Carbon Beach Asset Management LLC
0
3.75
7.5
11.25
15
Glamour Quintile 2 Quintile 3 Quintile 4 Value
14.1
12.5
11.5
10.1
8.3
Global Markets Average Yearly Returns to
Portfolios Sorted by PE, PB, and PCF (1980 to 2013)
8. How to Beat The Little Book
Wonderful Company at a
Fair Price
=
High ROIC +
High EBIT/Enterprise Value
9. Value > Quality
0
4
8
12
16
S&P 500 EW TR Magic Formula® EBIT/EV ROIC
10.37
15.95
13.94
10.46
Source: Quantitative Value (2012)
Returns to the Magic Formula vs its Parts: EBIT/EV and ROIC (1974 to 2011)
10. Value > Quality
0
4
8
12
16
S&P 500 EW TR Magic Formula® EBIT/EV ROIC
10.37
15.95
13.94
10.46
Source: Quantitative Value (2012)
Returns to the Magic Formula vs its Parts: EBIT/EV and ROIC (1974 to 2011)
11. Blending Value + Quality
4.5
9
13.5
18
100%ROIC
90%/10%
80%/20%
70%/30%
60%/40%
MagicFormula®
40%/60%
30%/70%
20%/80%
10%/90%
Acquirer'sMultiple®
17.917.517.216.616.41616.116.2
14.6
13.913.3
Source: Carbon Beach (2016)
Returns to the Acquirer’s Multiple®, Magic Formula® and ROIC (1973 to 2015)
EW
Universe
10.8
13. Mean-Reverting Mystery
“When you find a special situation and you decide
that you can buy for 10 and it is worth 30, and you
cannot realize it until a lot of other people decide it
is worth 30, how is that process brought about
—by advertising, or what happens?”
—Senate Committee Chair (1955)
14. Part 2: Contrarians at the Gate
Source: DeBondt and Thaler (1987) “Investor Overreaction”
15. Part 2: Contrarians at the Gate
Source: DeBondt and Thaler (1987) “Investor Overreaction”
17. Catch a Falling Knife
Source: Lakonishok, Shleifer and Vishny “Contrarian Value” (1994)
Growth and Valuation of PE and Sales Growth Portfolios (1963 to 1990)
Glamour Hi-Growth
Value
Contrarian
Value
Earnings 18.7% / 19.6X 16.9% / 6.3X 9.7% / 6.5X
Cash Flow 18.1% / 10.8X 16.3% / 3.9X 7.4% / 3.7X
Book Value 15.2% / 0.7X 13.9% / 0.3X 2.5% / 0.2X
Operating
Earnings
18.2% / 6.3X 16% / 2.2X 5.9% / 2.3X
18. Naive Extrapolation
Source: Lakonishok, Shleifer and Vishny “Contrarian Value” (1994)
0
45
90
135
180
Glamour High-Growth Value Contrarian Value
171.6
136.5
67.4
Average 5-Year Returns to Portfolios Sorted by PE and Sales Growth (1974 to 2011)
19. Naive Extrapolation
Source: Lakonishok, Shleifer and Vishny “Contrarian Value” (1994)
0
45
90
135
180
Glamour High-Growth Value Contrarian Value
171.6
136.5
67.4
Average 5-Year Returns to Portfolios Sorted by PE and Sales Growth (1974 to 2011)
20. In Search of Excellence
Source: Michelle Clayman (1994)
Average Five-Year Financial Characteristics (1976 to 1980)
Excellent “Unexcellent”
Asset Growth 21.78% 5.93%
Equity Growth 18.43% 3.76%
Price-to-Book Value 2.46X 0.62X
Return on Capital 16.04% 4.88%
Return on Equity 19.05% 7.09%
Return on Sales 8.62% 2.49%
22. “Bad” States of the World
Source: Deep Value via Barry Bannister, Stifel Financial (2013)
23. Part 3. Simple, But Not Easy
Source: Dresdner Kleinwort Macro Research (2006)
Minnesota Multiphasic Personality Inventory (MMPI)
Hit Rate for Diagnosis
Worst Psychologist
Average Psychologist
Best Psychologist
Simple Model
0% 17.5% 35% 52.5% 70%
70%
67%
62%
55%
24. Experts + Simple Model
Source: Dresdner Kleinwort Macro Research (2006)
Minnesota Multiphasic Personality Inventory
(MMPI) Hit Rate for Diagnosis
Inexperienced
Experienced
Inexperienced + Model
Experienced + Model
Simple Model
0% 22.5% 45% 67.5% 90%
83%
75%
67%
64%
59%
29. “In that Empire, the Art of Cartography attained such
Perfection that the map of a single Province occupied the
entirety of a City, and the map of the Empire, the entirety
of a Province. In time, those Unconscionable Maps no
longer satisfied, and the Cartographers Guilds struck a
Map of the Empire whose size was that of the Empire,
and which coincided point for point with it. The following
Generations, who were not so fond of the Study of
Cartography as their Forebears had been, saw that that
vast Map was Useless....”
— Jorge Luis Borges Del Rigor en la Ciencia, or On
Exactitude in Science (1946)
80:20 Rule
30. Ockham
Simple, Concrete Rules
“Most investors strive fruitlessly for
certainty and precision…
High uncertainty is frequently
accompanied by low prices”
—Seth Klarman (1991)
32. Price/Value Ratio Test
Source: Quantitative Value (2012)
Compound Annual Growth Rates for Price/Value Ratios VW (1964 to 2011)
0
3.75
7.5
11.25
15
EarningsYield
Acquirer'sMulitple(EBIT)
EBITDA
FreeCashFlowYield
GrossProfitsYield
BookValue
13.1113.51
11.68
13.72
14.55
12.44
Market
9.52
33. International Evidence
International EM premiums are 2 times
higher than the corresponding U.S. EM
premiums studied by Loughran (2011)
Source: The Enterprise Multiple Investment Strategy: International Evidence
US = 0.97% p.m.
34. Unpopular
“The reason our ideas have not spread faster
is that they're too simple.”
— Charlie Munger
35. Value Conjugations
I am a value investor
You buy cheap stocks
He is a bottom-feeding junk collector
36. Value Investing Ain’t Easy
“Give a man a value stock and he's invested for a day, but
teach a man value investing and he'll be in anxiety-ridden
mess for life.” — @EddyElfenbein
38. Einhorn’s Bad Year(s)
Source: http://mebfaber.com/2015/08/04/has-einhorn-lost-his-mojo/
+27% p.a. -4% p.a.
Einhorn -20.2% in 2015
39. Ackman's Bad Bets
Source: http://www.marketwatch.com/story/bill-ackmans-hedge-fund-posts-dismal-returns-as-valeant-craters-2015-11-12
Pershing -25% in 2016
41. The Market is Expensive
Robert Shiller Irrational Exuberance [Princeton University Press 2000, Broadway Books 2001, 2nd ed., 2005] Available at http://www.econ.yale.edu/~shiller/data.htm
Current CAPE 59 percent > Long-run average CAPE
26.1x
16.6x
42. Low Implied Returns
Source: My version of John Hussman’s method using Robert Shiller’s data.
Available at http://www.econ.yale.edu/~shiller/data.htm
3.8% per year includes 2.1% div. yield.
Negative in 2000 = 16+ years of sub-par returns (6.7% p.a.)
3.8% p.a.
8.9% p.a.
43. Since 2000 CAPE Peak
Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
44. Value Has Worked
Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
14% p.a.
2% p.a.
52. You are here*
1. S&P 500 Close > 10-month SMA
2. CAPE > Average
= Up and Expensive
Returned 8.3% p.a. and Declined -0.3%
BUT
If S&P 500 falls to 2017
= Down and Expensive
Returned -0.6% p.a. and Declined -65.4%
53. Five Ideas
1. Deep Value > High Growth / Quality
2. Contrarian > Naive Extrapolation
3. Simple Models > Expert Discretion
4. The Acquirer’s Multiple® > All Else
5. Hedge Signal Trend > Value
54. Deep Value
“Here’s your book for the fall if
you’re on global Wall Street.
Tobias Carlisle has hit a home
run deep over left field. It’s an
incredibly smart, dense, 213
pages on how to not lose
money in the market. It’s your
Autumn smart read.”
—Tom Keene, Bloomberg’s Editor-At-Large,
Bloomberg Surveillance