The Acquirer’s Multiple | Tobias Carlisle


Published: 2017

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The book is about how investors like Warren Buffett and Carl Icahn have successfully used the phenomenon of “mean reversion” and how an investor with a deep value strategy can systematically use it. “The Acquirers Multiple” (AM) is the EV/EBIT multiple. Carlisle got the idea for AM when he backtested Joel Greenblatt’s “The Magic Formula” (which uses EV/EBIT and EBIT/IC to sort out “wonderful companies at fair prices” and found that the use of EV/EBIT alone outperformed “The Magic Formula”.

YOU HAVE TO BE DIFFERENT TO BEAT THE MARKET. It goes without saying that you cannot beat the market if you just do what the market does. To outperform, one must dare to go against the market – and be right. The only way to get a good price on an investment is to buy what the masses do not want to buy. Then the price will be low, and this may mean that the share is undervalued.

CHEAP STOCKS = PROBLEM COMPANIES. Cheap stocks are often cheap for a reason. The business may have performed poorly and there is a headwind in the market. But that is when we should be buying – due to “mean-reversion”. When everything looks bright in a market, new players flock there, which leads to over-establishment and low profitability, which in turn leads to players leaving until the remaining ones return to good profitability – and so it is repeated.

MEAN-REVERSION IS THE EXPECTED OUTCOME. Investors as a group does not expect mean reversion, they extrapolate current trends. Margins are said to be the most mean reverting figures in the financial world. This is why cheap and unpopular stocks tend to beat the market over time, while popular growth stocks underperform over time. The growth of the fast-growing eventually and gradually slows down. The most profitable sees their profitability decrease over time. The same goes for the underachievers. Those who lose sales turn around and start growing, and the unprofitable return to showing black numbers.

“Mean reversion is the expected outcome. But we don’t expect mean reversion. Instead, our instinct is to find a trend and extrapolate it. We think it will always be winter for some stocks and summer for others. Instead, fall follows summer, and spring follows winter. Eventually.”

NOT ALL GROWTH IS GOOD. If a business with $1m in profit and $20m in capital (5% ROIC) reinvests $1m, it creates only $0.5m in value (in a market climate where investors demand a 10% return) – the invested capital has thus been directly halved. On the other hand, if a business with a profit of $1m and $5m in capital (20% ROIC) reinvests $1m, it creates $2m in value (because $1m in capital gives $0.2m in profit, which divided by 10% gives $2m in value). Companies with high returns on capital should grow. Companies with a low return on capital should try to get the capital out of the business over time.

SEE’S CANDIES. See’s candies had an EBIT of $5m in 1971 when Buffett and Munger bought the company. The business had only $8m in real assets which corresponded to a strong EBIT/NTA of 60%. Say that an investor would require a 10-12% return to own See´s, (interest rate was then about 6%). Then See’s would be worth $40 – $48m (60/10 and 60/12 = 5-6x), even though NTA was only $8m. Buffett and Munger paid $25m.

THE DIFFERENCE BETWEEN EBIT AND OPERATING EARNINGS. EBIT and Operating earnings are often used as equals but are not really identical. EBIT is calculated from the bottom of the income statement and operating earnings from the top. EBIT is the profits before financial expenses and tax are deducted. Operating earnings is sales less cogs, SGA and depreciation – ie free from “one-offs” that can affect EBIT (because that figure is found by working from the bottom of the income statement).

FIRE FAST AND TRUST THE FORMULA. You should not expect to find an infinity of great opportunities in the market. If you think you have identified an attractive deal, you should shop when you are 70% sure of your thing – not 90% or more, then it might be too late. Simple rules usually beat experts as well as amateurs. Carlisle advocates a simple and mechanical portfolio based on AM, and an investor should not try to “cherry pick” shares from the screen – it is easy to find “obvious errors” on the shares in the group, but very few manage over time to separate the chaff from the wheat. Greenblatt also saw that the group of investors who manually adjusted the portfolio overall returned significantly worse than the “formula” itself.

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