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Why Activist Investors and Other Contrarians
Battle for Control of Losing Corporations
DEEP VALUE
Deep Value and the Aquirer's Multiple by Tobias Carlisle for QuantCon 2016
Deep Value and the Aquirer's Multiple by Tobias Carlisle for QuantCon 2016
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
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)
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)
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)
How to Beat The Little Book
Wonderful Company at a
Fair Price
=
High ROIC +
High EBIT/Enterprise Value
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)
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)
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
Quality and ROIC
Source: Michael Mauboussin, The Success Equation (2012)
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)
Part 2: Contrarians at the Gate
Source: DeBondt and Thaler (1987) “Investor Overreaction”
Part 2: Contrarians at the Gate
Source: DeBondt and Thaler (1987) “Investor Overreaction”
Growth vs ValueLow
Glamour
Contrarian
Value
Hi-Growth
Value
High
Cheap Expensive
Growth
Value
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
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)
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)
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%
“Unexcellence” Prevails
Source: Deep Value via Barry Bannister, Stifel Financial (2013)
“Bad” States of the World
Source: Deep Value via Barry Bannister, Stifel Financial (2013)
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%
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%
Broken Legs
Simple models outperform experts because
experts override models too frequently
The Golden Rule
Simple models outperform experts
even when experts have access
to the simple model’s output
Google It.
The hurdle is not perfection:
It’s just got to outperform us.
Picture source: http://theoatmeal.com/blog/google_self_driving_car
Part 4. TheAcquirer’s Multiple®
“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
Ockham
Simple, Concrete Rules
“Most investors strive fruitlessly for
certainty and precision…
High uncertainty is frequently
accompanied by low prices”
—Seth Klarman (1991)
TheAcquirer’s Multiple®
Market Capitalization + Debt
+ Preferred Stock +
Minorities - Cash
Operating Earnings
or EBITDA
or EBIT
or EBITDA - Cap Ex
(a.k.a. Enterprise Multiple)
=
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
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.
Unpopular
“The reason our ideas have not spread faster
is that they're too simple.”
— Charlie Munger
Value Conjugations
I am a value investor
You buy cheap stocks
He is a bottom-feeding junk collector
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
All-You-Can-Eat Buffet
Source: https://twitter.com/RudyHavenstein/status/671458484685246464
Buffett -12.5% in 2015
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
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
Part 5. Hedging Big Bears
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
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.
Since 2000 CAPE Peak
Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
Value Has Worked
Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
14% p.a.
2% p.a.
…But Big Declines
Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
-62%
-56%
-33%
-49%
-30%
Moving Averages
http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs
Source: http://www.advisorperspectives.com/dshort/charts/timing/SP500-MMA.html?SP500-monthly-10MA-since-1995.gif
Returns to Trend and ValueDown
8.3% p.a.
6.0% p.a.
15.0% p.a.
Up
Cheap Expensive
10-mMA
CAPE
-0.6% p.a.
8.6% p.a.
S&P 500 (1950 to Date)
Declines to Trend and ValueDown
-0.3%
-45.6%
-17.7%
Up
Cheap Expensive
Trend
CAPE
-65.4%
S&P 500 (1950 to Date)
Trend and Value
MA Hedged Value
14% p.a.
2% p.a.
15% p.a.
Source: Carbon Beach Combo Value (PE, PCF, PB, EV, Sh. Yld) + 200d SMA SPY Hedge, Monthly Rebal
Truncated Declines
-62%
-56%
-33%
-49%
-32%
-30%
Source: Carbon Beach Combo Value (PE, PCF, PB, EV, Sh. Yld) + 200d SMA SPY Hedge, Monthly Rebal
-32%
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%
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
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
Questions?
www.acquirersmultiple.com
tobias@carbonbeacham.com
www.carbonbeacham.com
+1 310 451 0726
linkedin.com/in/tobycarlisle
@greenbackd
www.greenbackd.com

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  • 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
  • 12. Quality and ROIC Source: Michael Mauboussin, The Success Equation (2012)
  • 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%
  • 21. “Unexcellence” Prevails Source: Deep Value via Barry Bannister, Stifel Financial (2013)
  • 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%
  • 25. Broken Legs Simple models outperform experts because experts override models too frequently
  • 26. The Golden Rule Simple models outperform experts even when experts have access to the simple model’s output
  • 27. Google It. The hurdle is not perfection: It’s just got to outperform us. Picture source: http://theoatmeal.com/blog/google_self_driving_car
  • 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)
  • 31. TheAcquirer’s Multiple® Market Capitalization + Debt + Preferred Stock + Minorities - Cash Operating Earnings or EBITDA or EBIT or EBITDA - Cap Ex (a.k.a. Enterprise Multiple) =
  • 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
  • 40. Part 5. Hedging Big Bears
  • 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.
  • 45. …But Big Declines Source: http://www.advisorperspectives.com/dshort/updates/SPX-Dow-Nasdaq-Since-Their-2000-Highs -62% -56% -33% -49% -30%
  • 47. Returns to Trend and ValueDown 8.3% p.a. 6.0% p.a. 15.0% p.a. Up Cheap Expensive 10-mMA CAPE -0.6% p.a. 8.6% p.a. S&P 500 (1950 to Date)
  • 48. Declines to Trend and ValueDown -0.3% -45.6% -17.7% Up Cheap Expensive Trend CAPE -65.4% S&P 500 (1950 to Date)
  • 50. MA Hedged Value 14% p.a. 2% p.a. 15% p.a. Source: Carbon Beach Combo Value (PE, PCF, PB, EV, Sh. Yld) + 200d SMA SPY Hedge, Monthly Rebal
  • 51. Truncated Declines -62% -56% -33% -49% -32% -30% Source: Carbon Beach Combo Value (PE, PCF, PB, EV, Sh. Yld) + 200d SMA SPY Hedge, Monthly Rebal -32%
  • 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
  • 55. Questions? www.acquirersmultiple.com tobias@carbonbeacham.com www.carbonbeacham.com +1 310 451 0726 linkedin.com/in/tobycarlisle @greenbackd www.greenbackd.com