Episode #77: “In Order to Find Something Genuinely Undervalued…There’s Always Something that You Don’t Like”
Guest: Tobias Carlisle. Toby is the founder and portfolio manager of Carbon Beach Asset Management. Carbon Beach pursues a deep value, contrarian, Grahamite investment strategy. Toby has extensive experience in activist investment, company valuation, public company corporate governance, and mergers and acquisitions law. Prior to founding the forerunner to Carbon Beach, he was an analyst at an activist hedge fund, general counsel of a company listed on the Australian Stock Exchange, and a corporate advisory lawyer. As a lawyer specializing in mergers and acquisitions, he advised on transactions across a variety of industries around the globe.
Date Recorded: 10/20/17
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Summary: In Episode 77, we welcome author and asset manager, Tobias “Toby” Carlisle.
After discussing Toby’s background, including his time as an M&A lawyer and what drew him to investing, we jump into his latest book, The Acquirer’s Multiple.
Toby tells us that the book describes a simple way to find undervalued companies. In essence, you’re trying to find a company trading below its intrinsic value. This is how to get a great price as a value investor. Of course, you get these prices because things don’t look too rosy with the stock – there’s usually a crisis or some hair on it, so to speak. Toby tells us “In order to find something that is genuinely undervalued…there’s always something that you don’t like.”
This leads into a great conversation about what Warren Buffett seeks in a company, versus what Toby, through the Acquirer’s Multiple, seeks. While Buffett looks for wonderful companies trading at fair prices, Toby seeks fair companies trading at wonderful prices.
Toby goes on to tell us that for a company, there are two sources of value – the assets it owns, and the business/operations itself. You have to look at both together. Buffett looks at wonderful companies at fair prices, and is willing to pay a premium to book value, but that’s generally because Buffett is able to ascertain that the stock is worth even more. Joel Greenblatt took this idea and ran with it in his book, The Little Book That Beats the Market. The idea relies on buying companies with high returns on investing capital (ROIC). But Toby thought “what if you can buy at the bottom of a business cycle?” You could likely get better returns by buying very, very cheap, hence his focus on fair companies at wonderful prices.
The guys then discuss the merits of a high ROIC. Toby tells us that a high ROIC is meaningless absent a moat or competitive advantage. Don’t misunderstand – a high ROIC is incredibly valuable, but it has to be protected.
This dovetails into a fun stretch of the interview when the guys discuss the old Longboard study about how only a handful of stocks truly outperform… a study from Michael Mauboussin, which points toward the power of “mean reversion”… how a historical backtest of “excellent” companies (high returns on equity, assets, and invested capital) actually underperformed “un-excellent” companies – which were generally defined as being incredibly cheap. The reason? Mean reversion.
Finally, we get to The Acquirer’s Multiple. Toby tell us you’re trying to find the real earnings of the business. The guys touch on lots of things here – why Buffett & Munger actually don’t prefer this multiple… a comparison between The Acquirer’s Multiple (AM) and Greenblatt’s Magic Formula… and an example from Toby about the power of the AM using the stock, Gilead.
The guys then discuss implementation, including how many stocks you should hold to be diversified. They also touch on the Kelly criterion – how much of your bankroll you should bet on any given stock or investment. This leads to an interesting story about how Ed Thorp showed that the Wall Street quants were using Kelly incorrectly. The guys agree that “half-Kelly” tends to work pretty well.
The conversation drifts toward valuations, with Meb feeling angst about how nearly all institutional investors believe future returns will be below-average. The contrarian in him is excited. Toby tells us that every metric he looks at says we’re overvalued. Therefore, we should be cautious, but then again, Japan got to a CAPE of 100 and the US has been to 44. You just don’t know when to get out, and there’s no right answer…
The guys hop back into The Acquirer’s Multiple, discussing how to avoid the value trap… marrying momentum to it… how value is sitting on about a decade’s worth of underperformance… and whether the AM works globally.
The guys eventually switch gears, and turn toward Toby’s private “special situations” fund. In essence, Toby looks for situations when there’s a corporate act, say, a board-level decision to buy or sell a company, or pay a special dividend, or buy back a material amount of stock. He then tries to arb it. He gives us any example of how he made money using the strategy back when Obama was attempted to stop corporate reverse-mergers. But in all cases, Toby is still looking for undervalued, cheap investments.
There’s tons more in this episode: the “broken leg” behavioral problem… how investors trying to improve upon the Magic Formula tend to vastly underperform the Magic Formula left alone… how professional investors tend to behave just as poorly as non-professionals… what Toby is working on/excited about right now… and of course, Toby’s most memorable trade. It involves a basket of net-cash biotechs. While he made over 200%, if he hadn’t tinkered, he could have made 750%.
What are the details? Find out in Episode 77.
Links from the Episode:
- 1:57 – Thank you to the audience for their support of their show
- 3:19 – Welcoming, Tobias Carlisle, founder and portfolio manager of Carbon Beach Asset Management, as well as author of
- Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations,
- The Acquirer’s Multiple: How the Billionaire Contrarians of Deep Value Beat the Market,
- Quantitative Value, + Web Site: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and
- Concentrated Investing: Strategies of the World’s Greatest Concentrated Value Investors
- 4:00 – Tobias’s origin story
- 6:31 – Looking at his latest book, The Acquirer’s Multiple
- 11:00 – The Little Book That Beats the Market and The Little Book That Still Beats the Market – Greenblatt
- 11:10 – The Magic Formula
- 13:16 – Longboard Study/The Capitalism Distribution
- 14:13 – Rob Arnott Podcast episode
- 17:40 – Deep Value
- 18:12 – In Search of Excellence: Lessons from America’s Best-Run Companies – Peters & Waterman
- 20:10 – Global Investment Returns Yearbook
- 22:18 – The Acquirer’s Multiple
- 29:36 – Concentrated Investing and the Kelly Criterion
- 33:44 – The Acquirer’s Multiple Website
- 41:17 – Anomalies in marketing models predicting market performance
- 43:06 – Sponsor: Roofstock
- 44:14 – This year’s market hitting all sorts of weird records and the President taking credit
- 46:08 – Global investing and whether Acquirer’s Multiple works there
- 46:26 – Study on enterprise multiple in developed and emerging markets
- 48:04 – The broken leg problem
- 50:35 – The Little Book That Still Beats the Market – Joel Greenblatt/ Magic Formula Investing
- 54:30 – How often should average investors make changes to their portfolio
- 56:59 – Understanding the special situation investing that Tobias looks at for the firm
- 1:04:28 – Steve Sjuggerud Podcast Episode
- 1:04:53 – To what extent does Tobias follow other activists
- 1:06:12 – Any opportunities that have Tobias excited right now
- 1:07:03 – Rob Arnott Podcast with Covel
- 1:09:25 – Comic Wars: How Two Tycoons Battled Over the Marvel Comics Empire–And Both Lost – Raviv
- 1:09:59 – Greenbackd (Tobias blog)
- 1:11:16 – From Alchemy to IPO: The Business Of Biotechnology – Robbins-roth
- 1:12:09 – Tobias’ most memorable trade
- 1:12:57 – Van Simmons Podcast Episode
- 1:14:15 – “Is It Time to Do a Templeton?” – Faber
- 1:16:42 – Tobias focus on the Australian markets
- 1:19:28 – Following Tobias, com, Tobias Carlisle on Amazon, @greenbackd
- 1:20:19 – How the Acquirer’s Multiple is written
- 1:26:58 – Ned Davis books
- 1:27:33 – Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor – Klarman (Free PDF)
Transcript of Episode 77:
Welcome Message: Welcome to the Meb Faber Show, where the focus is on helping you grow and preserve your wealth. Join us as we discuss the craft of investing and uncover new and profitable ideas, all to help you grow wealthier and wiser. Better investing starts here.
Disclaimer: Meb Faber is the Co-founder and Chief Investment Officer at Cambria Investment Management. Due to industry regulations, he will not discuss any of Cambria’s funds on this podcast. All opinions expressed by podcast participants are solely their own opinions and do not reflect the opinion of Cambria Investment Management or its affiliates. For more information, visit cambriainvestments.com.
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Meb: Welcome, podcast listeners. Today we have a great show and a great guest. But before we get started, I want to say a big thanks from Jeff and I. First, we’re getting ready to cross two million downloads. It’s awesome to know there’s that many quant nerds out there that like listening to the show. Second, I want to thank all of you for leaving a bunch of great reviews, and terrible ones, too. We listened, we read them all. And lastly, a big thanks to all the people that keep sending us gifts. We’ve received not only a bottle of tequila and Canadian ice wine and smoked salmon and 10 of the best Virginia roasted peanuts I’ve ever eaten. They were amazing. Jeff’s requesting more.
But also, a dry erasable surf map of the world that’s now in my office. And last week, even got a parchment handwritten cursive letter that had a wax stamp on the outside. And I looked at the town and it made me…gave me this immediate sense of dread because the initial was like a Game of Thrones wax stamp, was the initials of, like, an ex-girlfriend who lives in that town. So I thought this was gonna be a reveal of, like, by the way, you have a 12-year-old son. Congratulations, Meb. But it wasn’t. It was just a thank you by the podcast, which was a big relief, as much as I love having a son, having another one that I don’t know about would be challenging. Anyway, let’s now get to our guests. So, today, we have a founder, portfolio manager of Carbon Beach Asset Management. He is an investment author with a deep value, contrarian-Ben-Graham style approach to the markets. He’s also got a legal background, did global M&A deals, which makes sense of his new book just out. It’s called the “Acquirer’s Multiple.” Welcome to the show, Tobi Carlisle.
Tobi: Thanks, Meb. Thanks, Jeff. It’s great to be here.
Meb: Yeah, absolutely. We were debating before the show because I’ve always called you Tobi, and whether your name was Tobias or Tobias, for some reason, which I’ve never heard. But it’s good to have you. All right. Let’s talk a little bit. We always start the show, a little origin story, little background. I’ve known you for a long time, but some context for our listeners. Give us give us a quick recap. Where you came from, how you have such a great accent, why are you in LA today, and what’s going on?
Tobi: I’m Australian. I grew up in the Australian outback and studied law, started out as a mergers and acquisitions lawyer in Australia. And I started in 2000, part-time, while I was still in law school in 2002 full-time. And just because that was sort of the very tail end of the Dot-com boom, but people were still doing lots of Dot-com stuff. It was all tech. M&A, web-based M&A, telecommunications, all the stuff that was sort of super fun at that time. And a roll came up in San Francisco doing the, pretty much the same thing, tech M&A. And so I took it, met my wife in San Francisco. She was a student. And she came back to Australia with me for a while. I worked in her house as a general counsel for a Dark Fiber, web internet firm, built a subsea cable from Australia to the U.S. And then that firm was sold. It was Australian public company that got sold. And I started working with a guy who had been an investor in that firm who was…he was an undervalued asset investor. He did some activism. He was sort of what I would call the reluctant activist. He didn’t go in expecting to have the fight, but he’d always be upset that the management wouldn’t do what he wanted them to do, and then he’d become activist. There was the full kind of take-them-to-court shop…
Meb: That sounds like my approach to relationships historically, is, like, I don’t go into it ever causing fights, but they just don’t see it my way, you know, then you kind of have to. Okay, keep going.
Tobi: I think he did it for the right reasons. But rather than sort of the very loud activism that is sometimes practiced, it was sort of much more kind of very constructive. But he was looking for real authentic changes at a business level. So I learnt a lot doing that. I wanted to be an investor. It sort of shifted me from trying to do that Buffett-compounding style investing to being undervalued assets balance sheet, deep value, and looking for hard catalysts like…activist kind of create catalysts, but looking for spin-offs or having the company sold or things like that. And my investing got much better as a result. Moved back to the states in 2010 with my wife to Los Angeles, which is where she’s from. And so now we’ve had a couple of kids, got another one on the way.
Tobi: Thank you.
Meb: So it’s a bit insane, number three, but good luck.
Tobi: Thank you.
Meb: All right. So you’ve written a bunch of books, at least four contributed to a few others. Listeners, we’ll link to these in the show notes. But you’ll recognize names such as quantitative value, deep value, concentrated investing and the new Acquirer’s Multiple. Let’s dive in with your new book. And we can also talk about themes of the other ones as we go through this. So before we reveal what you consider to be the Acquirer’s Multiple, let’s start a bit broader. In the beginning of the book, you write things like, “You must zig when the crowd zags.” The only way to go to price is to buy what the crowd wants to sell, meaning reversion is powerful. So this gives us a hint. But what is the top-line summation of what the book is about.
Tobi: The book is a simple way to find undervalued companies. It offers this simple method, which is the Acquirer’s Multiple. But the idea is that whatever method you use, what you’re trying to find is a company that is trading beneath its intrinsic value, and a lot of the reasons why you might want something like that. And the reasons are that it’s the only time that you’re going to get a good price as a value investor. There are other styles of investing, momentum, etc., but this is for value guys. The market is smart. The market prices things correctly most of the time or it overvalues them. So in order to find something that is genuinely undervalued, it’s often associated…there’s something that you don’t want associated with a stock, you don’t like the management, or there’s a crisis going on. You know, there’s a…it’s got some attachment to Puerto Rico, for example, which has had the hurricane, or even before that, it had the government debt problem. There’s always something that you don’t like. There’s some hair on it.
And for me, that’s not a reason not to do it. That’s sort of the reason why all of a sudden, you’ve got this thing that is cheap, that you can spend some time. Can it survive? Can it come out the other side? If it can, then you might have something that you’ve got the potential for an improvement in the valuation. So the valuation can go up. And you also get the elimination of the discounts, so the prices are often trading at a discount to that crushed value, and you can get both. So it’s a way to get good returns from sort of tragedy.
Meb: Yeah, well, so your book actually talks about Buffett a lot. And all listeners are obviously familiar with uncle Warren. But you tell us above it was seeking wonderful companies at fair prices. But when using the Acquirer’s Multiple, you know, you’re often looking at fair companies at wonderful prices. Give some details on here on the difference.
Tobi: Buffett started out as a deep value investor. So you’re looking at the asset value, you’re looking at the balance sheet. I always think there are two potential sources of value in a stock. One is the stuff that it owns and the other is the business. And the stuff that it owns can be, that can be a positive value or a negative value if they’ve got more debt than assets. And the business can be a positive value or a negative value if the business is losing money. And you have to kind of look at both together. What the Buffett guys, what Buffett has come to now is he’s looking at wonderful companies at fair prices. And what that means is a very high return on invested capital, which makes the assets in the business worth more than they would be just piecemeal. So it’s trading at a premium to book, but it’s worth more than that. Again, and a fair price means you’re roughly paying. You might be paying book or a little bit more, but it’s worth even more because of the power of the compounding.
The fair companies at wonderful prices are companies that tend to have a lower return on invested capital, but they can be bought at a much cheaper price. And the reason why you might wanna do that…So, Joel Greenblatt, very well-known value investor, very long-term, great record in special situations and deep value, and we’ll describe special situations a little bit later. But he studied Buffett’s letters to sort of quantify what Buffett had done. And Buffett has return on invested capital as one leg of a wonderful company and operating earnings on enterprise value as the determination of whether it’s a fair price or not. And those two things in context, in concert, Greenblatt found that it performed really, really well when you back-tested it, it beat the market.
Meb: And that’s the old magic formula.
Tobi: That’s the magic formula. It’s one of the best.
Meb: “The little book that beats the market.”
Meb: I think there’s now about 40 different little books that do something.
Tobi: He kicked that whole thing off. He created the magic formula. And that book is the best-selling investing book of, like, the last decade, something like that. It’s a very popular book. I looked at that, like, I have this bias for deep value. And I just, I thought, there’s got to be a good chance that that return on invested capital is picking these companies at the very top of their business cycle. And what if you could pick these companies at the bottom of their business cycle, or kind of ignore that error. So what I found is that it doesn’t help you to buy these companies with bad return on invested capital. It’s something that you wanna avoid. But return on invested capital, in the context of quantitatively assessing these things, reduces your returns. Better returns just buying very, very cheap.
Meb: And I wonder if that, this is just off the top of my head, I wonder if the reason that they include it, or Buffett includes it, is more that it’s a sleep-at-night mega cap sort of concept, or is it just…because there’s so many quantitative ideas that people talk about on TV, analysts. This is one of the reason that I originally became a quant as I would hear something, then look at quantitative data and be like, “Why is he even talking about that factor? Because that factor is actually, no, no, it doesn’t work, it works in the opposite way.” So there’s like common wisdom. I wonder. So, like, what do you think is the main reason they include that idea, and I don’t know if there is a answer, but, we’re like, what do you think? Is it a sleep-at-night? Is it like a comfort thing?
Tobi: There are two parts to that question. So I’ve looked at whether return on invested capital helps you in bad periods in the market. Does it help you in recessions and depressions? Does it help you when the market’s going down? The answer is no. The other thing is that Buffett is not looking for high return on invested capital over a short period of time. What he’s looking for is sustainable high return on invested capital, which means that you need some sort of moat or competitive advantage. So when you read Buffett’s letters, what he’s actually spending most of his time talking about is the quality of the moat, how you find a moat, absent that high return on invested capital is sort of meaningless, or it’s a target for competitors to chip away at. So return on invested capital is a very valuable thing, but it needs to be protected. Because everybody else wants that high return on invested capital.
Meb: You know, this kind of ties in to the old long-board study we talk a lot about. They were Blackstar at the time, but also JP Morgan has a piece we’ll link to in the show notes called “Agony and Ecstasy.” And a lot of people have repeated it since. But this old capitalism distribution, I don’t know if you’ve read this paper, but they looked at all stocks since the early ’80s, you know, and they compared them to the index. And something like two-thirds underperform the index over their lifetime, another 40% of the total had negative returns. And in, like, one out of five was essentially like a zero. And, you know, one of the takeaways…And a lot of the index returns were determined by these massive winners.
But one of the things is that when these companies, and one of the reasons that market cap weighting is a fine first step, but is not optimal is that by the time these companies become the Apples of the world or these industry leaders, you know, we had Rob Arnott on and he talked about, he did the top market cap company in each sector and in the broad market go on to underperform the broad market by about 3% a year going forward for the next decade because they have this target on their back, like, you’re talking about. So when you become super profitable, you know, that goes to show the rest of the world, “Hey, look, that’s a great business model. Let’s go disrupt that.”
Tobi: That’s entirely possible if that is the case. But another thing that I think about is, well, I spent the first half of my career as, like, a private equity, venture capital, M&A attorney. And company’s IPO at a really good time for them. You know, they’re picking the very peak of their cycle to go public. And so the first portion of their life when a lot of the gains are made is private. And they get to the market and they’re kind of heavily watered, they’re promoted, they’re expensive. That’s why I think IPOs don’t work. If ultimately the underlying business is strong enough, then it overcomes that pretty good valuation that it sells at when it lists. But I think for a lot of them they don’t, they’re sold as, you know, here’s a mine that were going to dig, here’s a well that we’re gonna drill.
Meb: Spoken like a true Aussie. We’re digging in the natural resources now.
Tobi: Here’s some tick.
Meb: You know, it’s funny you mention that. This is a quick aside, is that my go-to, I was a college student, late ’90s, and my go-to is I would buy these, you know, like every other person in the late ’90s, all these crazy biotech tech companies. But I would hedge it by shorting every single lockup. When your company goes public and these terrible companies that were literally going out of business in six months based on their cash burn or a year. And it would short the lockup. And the hit rate on that was something like 90%, you know, where these insiders didn’t care. They just wanted out. After six months and they would take any price. We just said it didn’t matter how much it went down. And to be curious about that I’d be interested to look. There’s gotta be some academic literature we’ll dig after the show and post it if there is. But on IPO lockup since then and how that still played out if it has, I’d be curious to see. Because, like, right now in the cycle, I imagine there’s probably similar opportunity just to short a bunch of these companies as they come off lockup. Who knows? We’ll look into it.
Tobi: It might be too late, but that’s, like, a snap blue eye print [crosstalk 00:16:29] run.
Meb: Yeah, they just laid off a bunch of people. Okay, we got off topic. Well, so we were talking about moat and some of these Buffett ideas. Should we move on to “Acquirer’s Multiple” or is there some more things you want to talk about on this topic?
Tobi: Just on moats. Michael Madison has done some really interesting research where he looks at returns on invested capital. So it takes S&P 500, divides it into, or ranks them all on return on invested capital, puts them into five buckets. And then he tracks their performance over the next 10 years. And he finds that what they all tend to do is trend towards the mean, so the very worst return on invested capital gets better over time, the very best gets worse, and they all sort of push together. There are a very small number, it’s about 4% that sort of resists this mean reversion. And it’s funny when you look at them, but they’re all the names that you would expect. P&G that often not selling particularly. It’s not an exciting business, but it’s one that you recognize because it’s everywhere. It’s a great brand name. They’re selling consumer durables, various things like that. But there’s no rhyme or reason to it. So he’s tried to find what drives it and what predicts it. And he’s been unable to do that so far.
Meb: You also, I think, it was in your book and I just printed out this 180-page PDF, so you cost us about two ink cartridges and killed about three trees, but I should have just read on Kindle, but I’m not a Kindle guy. I don’t read electronic books. Despite the fact that all of our books is, like, 90% Kindle readers. Anyway, so I read the book, and I think this is in your book where you said, you were talking about an old, what is the book where you use where it profiled, like, 20 famous companies. Was it in search of excellence?
Tobi: In search of excellence.
Meb: Will you tell me that story, and then the follow-up white paper?
Tobi: So Tom Peters, it’s regarded as, it’s described as the greatest business book ever written. Tom Peters is, I think, he was a McBain or McKinsey, I’m gonna get this wrong, he was a consultant. And he did this study on these, what he regarded as excellent companies. And they all had these, the criteria that you would, or the characteristics that you would expect to find had very high returns on equity, assets, invested capital growing very rapidly, and they’re also very expensive, though, a two and a half times book. And this analyst, Michele Clayman, she read that and she thought what if we looked at the reverse of that. What if we went in search of unexcellence. And so she found the very worst returns on equity assets invested capital. But as it expect, they’re all very cheap. There were, like, two-thirds of book something like that.
And that research has been updated by Barry Bannister at Stifel. And he’s looked at, I think he looked at it to 2013 from sort of 1972 whenever the good backtest data starts. And he found that basically, the unexcellent companies absolutely cream the excellent companies in terms of returns. And all it is is mean reversion in the price-to-book value, the price goes up for the cheap once the price goes down for the bad ones.
Meb: And then the companies, they were profile in the book. Didn’t their stocks perform very poorly as well? Was that a part of it?
Tobi: It did. So in “Deep Value,” my second book, I talked about this quite a lot. You can go and find these studies. If you look at studies of reputation, Morningstar gives these grades depending on how good your moat is, various sort of things like that. They almost all point in the same direction. As soon as something comes to everybody’s attention, the return sort of start to deteriorate at that time, and they tend to underperform. And on the other side of the scale, if something is, if people hate it, that’s a good time to sort of go and have a closer look at it.
Meb: It’s true in the macro world as well. There was some global investment return yearbook issue that came out from CSFB. I don’t know which year, but we’ll look it up. And they looked a lot of macro factors and country stock markets. And so all the ones that you would expect that people talk about on CNBC every single day is good. So, hey, this company’s GDP growth, or country’s currency returns, all of them are, it’s basically inverse correlation. So you want bad GDP growth and you want high inflation. You want terrible currency returns. And then there was a separate one which was, I think, they just study on the corruption index. You know, they rank countries by corruption. And the most corrupt countries, I think, had the best stock returns. And a lot of this, you know, again, goes with the…they just happen to be correlated to another variable, which is value. Because no one wants to invest in the Brazil’s and Russia’s, but, hey, they’re trading at P/E ratio of 5 or 10. And, you know, that’s, as our friend West would say, that’s the big muscle movement. That’s what matters.
Tobi: I discussed two of those studies in “Deep Value” as well. And the findings are exactly the same. I think there’s an economist article that I discuss in there and they talked about two stock markets: England and China, and juxtaposing. And England sort of not had a great deal of GDP growth. China’s had massive GDP growth. England’s stock market has massively outperformed China’s, hadn’t done so well up to the point of that study. I don’t know since then. But it’s popular fast growth economies get beat up very high. And a lot of that gain is gone. Unpopular, slow growth, boring economies, their stock markets get beat down and they do better.
Meb: I used to struggle with this. But I think it makes a lot more sense to me now where, observing investor behavior and seeing, I mean, let’s even talk about kryptos now. But looking at the lottery ticket stocks, you know, so many of the stocks that are the massive winners, you know, going back and looking at the characteristic at the time, if you bought a basket then, that’d be a terrible portfolio. But, you know, you see the big winners and the quantitative approach where you buy a basket of the cheap stuff, that’s probably a good lead-in. Why don’t we get into the Acquirer’s Multiple now. So tell us what it is, where its name comes from, how’d you come up with it.
Tobi: The Acquirer’s Multiple is, it’s just a valuation metric, and it’s a way of gathering a lot of information in one single metric. And so it looks at, on one hand, it’s looking at operating earnings, which calculated from the top of the income statement down. So it’s basically revs kicking out cogs, and then kicking out interest in tax because it has an impact on.
Meb: All right. So there’s about 10,000 people that just listen to this that have no idea what any of those things were. Explain again, start over.
Tobi: So you’re looking, you’re trying to find some approximation of the real earnings of the business of the…it’s not the cash flow coming into the business because that’s a separate measure, but it’s the accounting measure of cash flow going into the business. So it’s operating earnings as a rough sort of way of describing what’s happening. On the other hand, you’re looking at enterprise value. So if you’re familiar with the price earnings ratio, that’s on what price is market cap and earnings is profits after-tax at the very bottom of the earnings statement. The enterprise multiple or the Acquirer’s Multiple is, you’re taking the market cap, but then you’re looking at what the company owns. Looking at, does it have cash, does it have debt, are there preference shares on issue, which are all things that someone who acquires the company has to take over, so that real costs that you have to pay.
And if you test that metric against a whole lot of other ones: free cash flow, cash flow from ops, price earnings, price-to-book, any other fundamental ratio, you’d find that the Acquirer’s Multiple, which is just operating earnings on enterprise value performs the best, or it has to the point that we did the study. The reasons are pretty obvious. It’s looking for the sort of things that a careful value investor is looking for. And that’s a valuable kind of balance sheet, or you’re not paying very much for sort of the value of the business relative to the operating earnings that it’s generating. So you’re getting a cheap business with strong operating earnings. And if you buy them quantitatively, over time, it does better than anything else.
Meb: And so it’s interesting because you called it an industrial-strength PE multiple, which I like. And you mentioned that a lot of the PE guy, Private Equity guys, corporate raiders, that’s their preferred metric. It has no regard to profitability, right?
Tobi: It’s not profitability at the very bottom of the earning stone, but it is directionally correct for profitability.
Meb: And I may be getting this wrong, but doesn’t Charlie Munger not love this metric or something like this?
Tobi: So Buffett and Munger have said that they don’t like it. But their reasons are, one, EBITA, which is another kind of equivalent measure of operating earnings. It’s not a gap measure. That’s a measure that you have to calculate. So the measure that management give you, for EBITA, is just a marketing line in the glossy brochure that you get. You really have to go and calculate it for yourself. And the other reason is that depreciation and amortization and interest and taxes are real cost that a business has to pay. And so what are you achieving by kicking them out? And the reason that I kick them out is because it makes an apples-to-apples comparison between companies that have different capital structures possible.
So if you’re a private equity guy, if you’re an LBO a guy or a corporate raider, you can go in and you can manipulate the capital structure. You know, you can pay out the cash, pay off the debt, do whatever you want with it. That will impact the operating end. So you might have two companies, one has got $10 million in cash, one has got $10 billion in net debt. They’ve got different operating earnings because they’ve got, even though they’re operating, let’s say for, their operating earnings are identical, they’ve got different profitability because one has to pay interest, and that’s tax-deductible. And the other one gets interest back in. This just makes them comparable on an apples-to-apples basis.
Meb: Yeah. It’s interesting. This metric and a lot of one similar to it, we’ve looked in a lot of the academic literature, too, and for a lot of the people that do private equity, I mean, massive, massive industry. And, you know, for a long time in venture capital, the belief has been that the top quartile private equity shops, you know, have persist, and they have these massive returns. You know, the Yale is the world. But there’s been a lot of really interesting papers that have come out that look at metrics similar to the Acquirer’s Multiple and say, “Hey, by the way, a lot of what private equity is is simply buying cheap companies like the Acquirer’s Multiple and then maybe either using a little bit of leverage or simply smoothing it out.” So it has a lot of far-reaching implications, you know. In your book, you talk about comparing it to the magic formula as a good kind of comparison. Why don’t you talk a little bit about that, the comparison to what Joel did and kind of the results?
Tobi: One of the challenges that you face as an investor is trying to explain in a very simple way what it is that you’re doing. And so I thought that the magic formula, a little book that beats the market in the magic formula was a really clever, simple explanation of what Joel does. I know that they do a lot of other things in addition to that. And so I was looking for some way to describe simply what it was that I was looking for. And it just so happened that when I ran the test, the Backtests on the returns, I found that the magic formulas return on invested capital didn’t help with the returns, and if anything, had probably dampened the returns to just a pure earnings multiple. So Greenblatt calls it the earnings yield, I call it the Acquirer’s Multiple, but they’re roughly equivalent. It’s just that one is the inverse of the other essentially. And I do a few other things to mine.
So the next challenge that I found when I was describing it as the Acquirer’s Multiple was people would look at the stocks that we were buying and they’d get very nervous about the fact that we had bought, what looked like pretty junky companies. And I’d have to tell them that the reason we own the junky companies is because that’s the stuff that nobody else wants to own, which is why it’s cheap. Something that’s popular will never get cheap. You’ll never get a chance to buy it at a point where…Well, sorry, I’m not saying it’ll never get cheap. It’ll never be cheap while it’s popular. Often you do get an opportunity to buy these things, you’re just buying them 5 or 10 years after the point where they’re very successful.
So recently I bought, about six months ago, I write about this on Twitter at the time that I was doing it, we bought Gilead. So Gilead was a very popular stock for a long time, topped out at 120 bucks in June, 2015. When we were looking at it, it was 66 bucks, so it’d fallen almost 50% over that period of time, but it also got very, very cheap. I think it was trading like three times on an Acquirer’s Multiple basis. And the reason was that there was an expectation that the earnings were to continue to fall, management were kind of running what they would call a lazy balance sheet, there was probably too much cash, not enough debt for the corporate finance guys to get in there. And they wanted them to buy something. And they hadn’t done that. You know, my particular biases I don’t want them to buy something. My preferences, they can keep the cash and don’t take on any more debt. But I bought it very, very cheap. And I didn’t know what was gonna happen, but I knew that something was gonna happen because management don’t just sit there and let it happen to them. It’s often their compensation is tied to stock. And then, of course, after a fairly short period of time, they bought something. So the stocks run from 67, I think, it’s sort of in the high 80s or something like that. Now, it’s only a short few months that that happened.
Meb: And so in the book, by the way, so the approach was to buy, I’m trying to remember, was it 50 stocks, 100 stocks, is quantitative screen, you updated it yearly?
Tobi: So “Concentrated Investing,” I did a lot of research on portfolio construction. That’s basically what that book is about. It’s one of those funny things where Ben Graham said 30 stocks, the academic literature says 30 stocks. It turns out 30 stocks is about right if you test it. But the reason for “Concentrated Investing” was it looked at the Kelly criterion. So Kelly has become very popular as a sort of way to size for value guys because Buffett endorsed it. Kelly is basically looking at how much you should bet of your bankroll, how much you should put into any given stock. And it depends on what you think your edge is, what the odds that you can kind of compute from it. It’s a mathematical calculation. And it’s been popularized by Mohnish Pabrai and a few other guys like that.
Ed Thorp, he lives in Los Angeles, his son went along to a value investing Congress out in Pasadena, and he said everybody is talking about the Kelly criterion, which you sort of were the first person to use and popularize it. And so Ed Thorp wrote this mathematical proof showing that, the analysis that the value guys were using was wrong. Basically, the fatal thing to do in betting using the Kelly criterion is to overbet. You never want to overbet. So what the Kelly criterion does is it described the outer limit of how much you should bet. Anything less than that is okay. But you want to seize your opportunities when you get them so you want to bet up. And he said that, basically, people are overbetting because they’re not taking account of how difficult it is to make those calculations in real, you know, it’s not a mathematical calculation…
Meb: Through false acquisition, too, right, yeah.
Tobi: Right. It doesn’t account for black swans. The main thing is that he was using on a blackjack table basically where you’re presented with the bets in series. But when you run a portfolio, you’re presented with these bets in parallel. You get them all at the same time. If you use it, any net present value positive bet should have a small portion of your portfolio, which means that the government table should have some portion of your portfolio. And that crowds everything else down. If you have two bets that call for more than 50% of your portfolio, you don’t take that bet because that risks blowing up. Kelly never does that. You have to scale them down relative to each other. And that’s a difficult thing to do. So basically, the book just sort of describes a less concentrated version of what everybody else has been trying to apply as the Kelly criterion.
Meb: I’ve often heard over people just say Kelly, take Kelly and divide it by two, take half Kelly.
Tobi: Half Kelly works really well because you lose…you don’t lose half the return, but you lose…it’s right on this nice little part of a curve where you’re losing a great deal of volatility without losing as much of the return.
Meb: It’s always easy to optimize, people always optimize on CAGR, but never optimize on the drawdown or MAR ratio or ulcer index. Like, the pain it takes to get through that equity curve. So, all right, so in the books that we use 30 stocks as a rough…
Tobi: Rule of thumb. If you’re applying it in a quantitative way, 30 stocks is the right number.
Meb: Okay. It is funny because…All right, and so just a couple other ballparks. I mean, because a lot of these backtests, you know, did, I mean, it was like mid high teens returns, which is awesome. And it’s updated through, I think, last couple of years. What was the whole date range you used?
Tobi: The backtest is in the book. So the book backtest is to sort of June, or it’s to June this year.
Meb: Oh, wow, cool.
Tobi: It’s as recent as, right…So I asked the guys at Euclidean Technologies, so they’re an AI value investing quanti-firm in Seattle, and they’ve got this great backtesting set up there for specifically this kind of value backtesting. And I just thought it’d be cool to work with those guys, so I contacted them. They very generously helped out with the backtesting. And their backtests appear in the book. So they did the backtesting. I’m not entirely sure. I think it may be 50 in the book. It might be…
Meb: We’ll look it up. And so you guys have the ability to screen for these stocks on your website, correct?
Tobi: Right. So I’ve got a little website, the Acquirer’s Multiple, which…
Meb: Great name. Shocking that was available.
Tobi: Yeah, because it’s so long.
Meb: Yeah, yeah, yeah. That’s a good point. All right, so is there like a…give me the range of the multiple. Like, what are you looking for? Is there like a particular number that you think is absolute kind of line in the sand or that’s decent?
Tobi: I think you’re pretty safe south of 10.
Tobi: Anything under 10, you’re okay. There’s a little bit of gain to be had in that. The one thing that that metric doesn’t take account of is the quality of the business. There are some businesses that are worth paying more for. That is entirely true. It’s just that they’re very hard for most lay or even professional investors to kind of distinguish between the two. But they’re definitely, some are worth more.
Meb: There’s, I think, about five questions that just came to mind, but we’ll go through these in order. As you think of kind of the absolute level…and I’ve always wanted to ask Jack Bogle this, you know, he was a buy-and-hold guy. But in his recent book that he just updated, he’s forecasting 4% returns for U.S. stocks, whatever bonds are now, 2 and a half, so 60/40 does like 3 and a half. And I’ve always wanted to ask him. Maybe I’ll have to go to Omaha and ask Warren and Charlie, too, and say, “Look, I know you guys aren’t market timers. But Buffett, you’ve talked about absolute levels.” You know, his old metric was, what was it, market cap to GDP, which we’re reaching levels that are like higher than he warned in the past. But I say I wonder if there’s a level, Jack or Warren or whatever, at which pick your valuation metric, you know, we love the 10-year P/E ratio, at which you would say it makes no sense doing stocks and you should sell. I really want to ask those guys that. And I’d pick the number. Is it 50 times earnings, is it 100, is it 500?
And anyway, [inaudible 00:35:29], my question to you, and you can talk about whatever you want was, would be…I wonder if there’s a point, because we’re looking at the stock market, U.S. market now and we can get into foreign, too, but where a lot of the metrics on median or absolute valuations are getting pretty high. And I wonder if, you know, it’d be fun to look at this study to where you actually cap the level of Acquirer’s Multiple and say, “Look, we’ll buy these 30 stocks. But if none of them are,” and this probably never happens in history, “but if none of them were below 20, or the whole market was getting above a certain level.” You have any thoughts there?
Tobi: Well, I’ve backtested that thousands and thousands of times trying to find the right level. And the problem is, in the U.S., like, you can go back to either just looking at the index, you can get data back to 1980 or looking at specifically Acquirer’s Multiple fundamental data that’s good, I think you can get back to about 1963 or something like that.
Meb: Chris’s database.
Tobi: Chris, right. The problem that you have is that valuations have roughly gone up over time. And I don’t know if that’s circular or cyclical. I’ve got no idea. My instinct is that it’s cyclical, but it looks pretty circular right now. And much, much smarter guys and I have looked at that and come to wildly divergent opinions on that. I’m sort of in John Hussman’s camp where I think that returns are gonna be really, really low and there’s probably gonna be a lot of big, ugly draw downs in between to get there.
Meb: The only thing that gives me pause on that, I totally agree with you 100%, is, like, we track every single big institutional money manager in quant shop. And, I mean, there are dozens, AQR, research affiliates, you mentioned Hussman, but GMO. I mean, every single one. I cannot find, I asked on Twitter the other day, I cannot find a single institutional investor…and listeners, email me feedback in themebfabershow.com if you know of any that projects higher than average historical returns for the U.S. stock market. So part of me hates that all of the sentiment and projections are lower, you know. And some of them are way lower. GMO is, like, negative returns for U.S. stocks. But they’re contrarian on me hates when everyone lines up on the same size as, like, what am I missing? What are we missing?
Tobi: Can you make a momentum argument for it? Can you say the momentum has been so strong that it’s gonna persist for a long period of time?
Meb: You can make a lot of arguments. There’s none that really sit well with me. We talked about this on Bloomberg this week where we were talking about, we call this the Jay Cutler Bull Market, or the newer one which was Wag’s interpretation was the Shrug Emoji Bull Market, which was everyone knows the stock market is expensive, they don’t know what else to do, they don’t care, they have too much scarring from the last two bears, and they’re just like, whatever. That’s my general thesis. Very precise and intellectual thesis, whatever.
Tobi: Look at CAPE. I mean, you can look at Buffet’s measure, you can look at Hussman’s measure, you can look at Tobin’s Q, any of those. Like, that’s replacement assets and market value of assets. Everything says we’re sort of at extreme levels of over valuation. But then I look at, and I’m sort of, that means to me that we should be very, very cautious, whatever that means. But then I look at, you know, Japan got to 100 times CAPE, China has recently been at 100 times CAPE, the U.S. has been at 44 times CAPE…
Meb: Maybe, I love that level.
Tobi: …we’re like 41. It’s just, you just don’t know when to get out, right? And there’s no correct answer. And there’s nowhere else, what else you gonna do with your money? Stick it in cash, you get nothing.
Meb: I got a lot of good ideas. But one of the nice things about breath, and when you’re looking at a universe of 2,000, 3,000 stocks, you know, which I assume was kind of your universe, I think of stocks over 50 million or 100 million. So you there’s almost always something in crisis. So there’s almost something always puking into what would be a cheap Acquirer’s Multiple. And the same thing applies the countries. We have 45 countries. And so then tens of thousands stocks globally. Is there any, so I think like a listener question would probably be something like, “All right, Tobi, I got it, I like it. Acquirer’s Multiple, you know, relies on this mean reversion, but it’s not always guaranteed. Is there any way to avoid buying an asset that looks cheap, you know, poised for reversion, but just keeps getting cheaper and is the proverbial value trap?”
Tobi: I wish I knew. It’s probably marrying momentum, too. But I’ve tested that too, that, you know, that the returns are fine but they’re no better. They have a slightly different profile, like, they look a little bit better at the end of a bull market, they look a little bit worse kind of coming out of the bottom of a bear. The problem that…Value offers some good things and some bad things. One of the good things that it offers is it has this sort of idiosyncratic return stream that’s not necessarily tied to what the market does. So early in the 2000s, if you’re a long only value investor, you look like a genius.
Meb: Didn’t even have a bear market for those types of portfolios.
Tobi: It did in the late 1990s.
Tobi: It sucked.
Meb: It was mainly a, just massive underperformance relative. Like, did it actually go through like a pretty bad bear or it just didn’t rip like everything else?
Tobi: I mean, you can go back and look at the magazine covers at the time. Like, that has Buffett lost his touch all that sort of stuff. And value guys were shutting up shop. And there were no sort of value launches from that period. But all the guys were sort of, like, 40s now who started in the early 2000s, who were famous value guys have got this spectacular long only return profiles with up almost every year 2000, 2001, 2002, 2003 when the market was getting crushed. And it’s just because value has this, it doesn’t track…it tracks the market, but it doesn’t track it so closely that you can’t make money. And you can lose money in periods like this. So it’s underperformed for the last seven years or something like that.
Meb: Yeah, I think it’s even longer than that. Let’s talk about that. So this is a challenge. And this is what I think creates the actual anomaly itself is that, you know, any investing approach can go through long periods of underperformance. And value is sitting on a big fat, almost essentially a decade, as you mentioned, where its growth has just been, other variants market cap weighted have been ripping relative to value. Maybe talk a little bit about that challenge. I mean, how, what is the timeframe you need, is there anything different about this cycle? Any other thoughts on when you looked at maybe your backtesting? You know, is there periods that look like this in the past?
Tobi: The late 1990s were worse, I think, but I don’t know if…It wasn’t as prolonged. It was deeper, but it was shorter. But even that is enough for professional money managers to have their fangs yanked. And that’s happened kind of…And that’s kind of, I think that’s what creates the opportunity for value. If you can grit your teeth and get through those periods, you will get these big catch ups. But last year there was a big catch up. And I think that this year it’s been much tougher for sort of deep value guys. If you’re a Buffett compounder, this has been a pretty good year. But for deep value guys, it’s not been a great year.
Meb: Particularly last year, if I remember correctly, it was a lot of the post-election, right? Was that where value kind of really ripped?
Tobi: I think it had been, for us, it had been a really good year up to that point. And I really wanted, I would have taken a knee.
Meb: Suits the opposite.
Tobi: I would have taken a knee at that point. But we were looking pretty good at that point. And then it absolutely ripped the end of the year. So it looked like we got silly numbers. I’d have rather taken that post-election period and just put it into this year and then we’d have looked pretty smart two years in a row. But as it happens, we look like we’re popping up last year’s numbers and we’re just not doing anything this year.
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Meb: Well, we’re entering the realm of totally meaningless, but interesting stats. I had mentioned the other day that if we finish up in October, which we should, this will be the 12th month up in a row in U.S. stocks. And that has only happened more once ever. And it was in the 1950s, had 15 up months in a row, interesting but useless stat. And then second, we’ve never had a calendar year that’s been up every month. So we’ve got two months to go and well, it hits all sorts of totally meaningless metrics, which means Donald Trump will continue to tweet about the stock market hitting all-time highs, which is, I mean, I’m sure he doesn’t care. But, like, I feel like it’s just karma asking for just a massive, massive bear market crash, right? It’s like that the stock market is hitting new highs due to me, but you know that’s not how it works, right?
Tobi: I mean, I don’t think that presidents have much impact on the stock market at all. But you…
Meb: Zero, I think.
Tobi: You’re calling down a lightning bolt, I think, if you’re, particularly with evaluations and how well it’s been going, I think you’re on a hiding to nothing.
Meb: It’s funny because I remember watching election night when I was with a common friend Alex Rubalcaba. And he’s, you know, big-time Democrat and pretty independent, just, he was enjoying the show. But I remember talking that night because we were trying to get out this tail risk fund that we had. And didn’t have it out yet. It’s out now. And I remember feeling so much FOMO that night because, “Oh my God, these futures are down hundreds of points and it’s gonna be Armageddon. And this is, you know, we should have had this out.” And sure enough, it’s, you know, what happened. Surprised everyone, of course, as the market loves to do went straight up for the rest of the year.
Anyway, so, all right. We’re in bull market in the U.S., valuations are high. One of the things you didn’t mention in the book, but I know you and your Aziz, so obviously, you think not just in terms of the U.S., talk to me about global investing. Is this something that you think works well in foreign markets, too? Have you looked at it? What idea is there?
Tobi: The research, it’s not my research, but there’s a study looking at the enterprise multiple, which is a pretty close facsimile to the Acquirer’s Multiple. And it looks at it in developed and emerging markets, and in every single market it gives a very big difference between the most expensive and the least expensive on that basis. And it tends to beat, and the cheapest tend to beat the market. So it’s sort of agnostic to markets. It tends to work fairly well globally. The challenge is always, when you dig into these markets, they’re often pretty small, and they don’t have a lot of stocks in them. So their return to much more idiosyncratic. The nice thing about the states is there’s so many stocks across so many different industries. And you can get…it’s the best place to kind of do the backtesting. It’s also been a very good market.
Meb: Yeah, I mean, you know, for someone who’s had their hands dirty doing like the CAPE ratios for the past number of years, we…you notice of the 45 developed and emerging market countries, which essentially are investable, we’re not even gonna get into frontier, you get down to, like, the 3 or 4 smallest out of that 45. And there’s a couple indexes that have, like, 10 stocks in them. You know, the Czech Republic or some of these countries. And so you got to be a little aware that, for example, you know, the entire Greek stock market is the size of like Best Buy. So you just…But if you stick to the developed, for sure, or treat emerging markets as a whole, there’s still tens of thousands of stocks out there and pretty wide breath.
Two other questions, kind of in the same vein, starting to think of a little bit about practical implementation. But Jeff had a question on human involvement. And I don’t really understand the question even though I read the book, so I’ll ask you, and then we can go. So, Tobi, your book brings up the behavioral challenges of buying when the headlines are bad. You mentioned the broken leg problem. Can you explain that and what our response should be?
Tobi: There’s a lot of literature around experts versus algorithms. So that just any computer-driven or any algorithmic thing where you’re asking a series of questions with a yes/no answer, and at the end of that you’re determining some behavior. Experts have all their biases that they bring in it. Pretty consistently, they’ve found across lots and lots of different studies and meta studies, the algorithm always outperforms the expert. And so the reason, the example that is always given, so you have some data about Johnny going to the theatre on a Friday night that he likes action movies. If it’s hot or if it’s raining, that might affect his behavior etc., etc. And so you have this extra bit of data one day that’s not in your algorithm. He’s broken his leg. Should you then be able to use that information to determine whether you can make an assessment as to whether he goes to the theatre or not. And the answer is no. And the reason is that we find way too many opportunities to exercise our discretion, everything looks like a broken leg. And this is particularly apt when you’re looking at deep value stocks because they all, there’s a reason not to buy every single one of them, which is why they’re cheap.
Meb: One of my favorites is when we used to give kind of these CAPE presentations around the world. And we’d have the slide that everyone loved, which was on the left side, it was the 10 cheapest countries. On the right side, the 10 most expensive. And I used to joke, and I would label it, the left column as career risk, you know. So I was like, “Look at this,” and when I gave these speeches in 2013-14, even 2015, the crowd would like audibly groan when they saw the left side. Because it was Brazil who’s going through their own great oppression, in Russia who’s invading countries and everything else, in Greece just like Basque. All these terrible, like the hairiest, wordiest, gross countries. And stuff on the right was like the shining, you know, stars, the LeBron James. It’s like U.S. and Japan and Ireland.
But the behaviors actually changed in the last few years because these markets have been ripping and the left side people are like, “Oh, yeah, should I just go put my whole IRA into Russia now, Meb?” You know, like, it’s totally different behavioral bias. But you mentioned it because there’s so many excuses as to why…you can think of a thousand reasons not to by the left side. And so you talked about this in the book, and I thought this was a great example of…so Joel Greenblatt when he did “The Little Book that Beats the Market,” he built a companion website. I think it was called Formula Investing, where you could screen and do it on your own, or you could have him do it for you. Maybe tell us the story and what the takeaway was.
Tobi: They offered two types of accounts. One was automated, and one you could sort of cherry-pick off the screen that they offered. And this sort of offered the cherry-picking…they offered the automated one as sort of, I thought, as a throw-away idea at the very end. They weren’t planning to do that. And so after like two and a half years, I think, of data, Joel went and looked at the performance of them and he found that the automated ones had massively outperformed the cherry-picked ones. And then he looked at the behavior of the automated…of the of the cherry-picked ones that had sort of worked and he founded that people that bought all of the stocks on day one and they just forgot about their portfolio. So they didn’t touch it for the entire period. Kind of amazing. It’s evidence for the fact that we kind of exercise our discretion to do the wrong thing and we’re better off sticking pretty closely to the model.
Meb: And this is one of the huge beauties and terrible parts of the automated services. So, you know, I’ve implemented automated investing for the vast majority of my portfolio. And it’s beautiful because I don’t even think about it. It runs words in the background, great. But a lot of these robo-advisors have the ability to go in and change the allocation instantaneously. So you could go on, if you have wealth front or betterment tomorrow, and be like, “You know what, I’m gonna move my risk from 80 to 20.” So it’s just market timing clicking to change the whole portfolio. And I’m like, “That’s a terrible idea. You should have it so that it essentially…” And that’s the beauty of having financial advisors, is your allocations are essentially locked. And you have to talk to someone before doing something really stupid.
Tobi: Bitumen, I think, Dan, I saw Dan Egan talking about this a little bit on one of the, I don’t know whether it was Brexit or whether it was the election, they stopped people from trading for a period of time.
Meb: Also, there’s two things. One is, and that’s kind of unrelated. That was just them pausing trading on the day of something crazy happening…
Tobi: Just stopped people trading.
Meb: No, but it wasn’t for stop people trading. It was just like they didn’t want to execute during the really high volatility. What they do do is they pop up a screen that if you’re gonna trade and say, “Hey, you’re gonna have these negative tax implications if you change this portfolio. Do you really want to do this? Because basically it’s really stupid.” And he said that’s cut it down a lot, but you still have the gun in your hand in my mind. But, look, I mean, if you have a financial plan, already have your own account, you can still call him and be like, “No, I have to move to cash. I don’t care anyway.” So it’s not like you can’t, almost I wish then this goes back to this idea where you had over the 10-year lockup fund that penalizes you. Like, I wish there was some sort of behavioral checks and balances that keep people from doing dumb stuff. It’s almost, like, it’d be great if you had to do instead of the betterment idea of just one pop up screen, like, but you’re gonna have to go through this 30-minute, you know, essentially education course on why this is really stupid. And if you still want to do it, you could do it at the end. I feel like that that would be like a good buffer. Or you have to wait, you know, I don’t know…
Meb: You’re the lawyer. You can’t do that for legal reasons, but, yeah, as cooling off. But it’s always interesting, yeah. Because if you think about it, and there’s a fine line, because Joel who’s run this special situation portfolios, and a lot of people use the quant screens as a first screen, and then dig into their security analysis background to look more into these. And that’s why a lot of people use it. It’s the way a lot of people use the 13F sort of things. But it’s also a huge temptation to just do dumb stuff.
Tobi: It affects everybody. I think I wrote about in “Deep Values.” Well, professional investors have exactly the same. Professional investors behave just as badly as people who aren’t professional investors. It’s not the fact that you’re doing it supposedly professionally, bringing some sort of discipline so it doesn’t seem to help people at all.
Meb: All right. So for the do-it-yourselfers out there, you know, wants to do this on their own, like, what’s the time requirement? Is it something where, you know, “Hey, once a year, they’re gonna screen, update the portfolio, and check in in a year?” What’s kind of your recommendations there? Should they actually go dig through all the 10 Ks and Qs?
Tobi: It depends. So the Acquirer’s Multiple has this plan on it where you can invent, you can go in once a year, take all stocks of that screen, buy them and return the week before the year is up so you can sell your losses to get that, bring all of your losses into the current tax year. And then you can sell your winners one day after the end for you to put your, push them into long-term capital gains and ideally to push them into the next tax year as well. That makes it really, really simple.
If you wanna be more active, you can be more active. You can do it on a quarterly basis. I don’t think that you get much. The only thing that doing it on a quarterly basis does is that if there’s some sort of unusual wrinkle in the year, so year-end tends to be the markets depressed a little bit for tax or selling. The beginning of the year it tends to be pushed up a little bit because people are rebuying. You might be just avoiding that. If you do it on a quarterly basis, your own personal returns might start to look like the backtest returns. But you don’t need to do it. But some people, you know, for them it’s fun, it’s sport. You can go in and you can do it on a weekly basis if you want. I wouldn’t recommend it.
Meb: That’s terrible advice. The weekly basis. I agree. You see a lot of these screens, and I think a lot of the devalue strategy is the more you muck around with it, often it actually, it can hurt, you know.
Tobi: It takes value a long time to recur. So one of the nice things about value is that you get deeply undervalued stocks. Or in a given year, tend to keep on working out to about five years because that mean reversion takes so long to sort of fully express itself.
Meb: There’s a lot of things you could do. You could just tack on like a trailing stop for these and then…
Tobi: I don’t think that’s a good idea.
Meb: Oh, why not?
Tobi: So trailing stops on individual stocks, trailing stops tend not to work particularly well because they just whipsaw you out at the wrong time. I think the only time that you wanna be doing something like that is using something like a 200-day at a market level to hedge. So that’s not hedging your portfolio. Your portfolio can go down on and then you don’t put the hedge on. Your portfolio it could, you know, in some rare unicorn scenario be going up and you hedge the market which is going down. So the early 2000s, you could have done that and your returns would have looked very good.
Meb: All right. So you run a private fund as well. It’s not just buying the Acquirer’s Multiple, right? You guys do quite a bit of special situations. You wanna talk about what do you guys look for there?
Tobi: We’re deep values special situations. So a special situation is something that it’s a corporate act. So it’s a board-level decision to do something. They got to buy another company, sell a company, sell the entire business, pay out a special dividend, buy back a material amount of stock, spend something off, or buy another company. And so we might, where there’s some hard catalyst where there’s an event where two things are going to be made the same price and there’s a difference between them, we might try and take a position in that. So we’re looking for returns that aren’t correlated to the market. I mean, that’s been the case for good annual. They’re largely uncorrelated. But so the sort of things that we’re looking for.
So last year, for example, we hadn’t been doing merger arbitrage. We hadn’t been doing any merger arbitrage. When the Obama administration, when the Treasury Department stopped the reverse mergers, the mergers that were being undertaken to escape the U.S. tax jurisdiction. All of the spreads in the merger arbitrage blew out really wide. So we went in and we found ones that were very cheap, that weren’t subject to this stoppage on the reverse merger. And so one we found was Humana, which was being taken over by Aetna. We calculated at the time it was 37% below the bid. And the bid was to close in about six to nine months. And so we thought, annualized, that’s a very high rate of return. And we made it a big position because we also thought it was very, very cheap. That’s our first set of requirement, that it’d be very cheap.
Over the course of the year, it traded tightly, and we took some off. It traded wide, and we put it back on. They eventually got blocked by the administration. Different bases that were blocked on competition grounds, which is DOJ. At that stage, we put a little bit more on and we traded some options because we thought that expire before the court date.
Meb: Jeff just woke up.
Tobi: Which happened. So we love options. We do leaps and ports. We trade them lots of different ways. But we do it as value guys. So we’re looking at a way to get…we’re looking at a way to shape the value investment. So rather than buying the equity, if we think there’s some risk in the equity, we might buy a leap so that your downside is the size of whatever you buy in the premium. We might sell a leap…we might sell, sorry, we might sell a rich poor, which is the same as getting long. The stock has the same downside as being long, the stock, but you get your catalyst up from. The risk to that is that you get, put the stock, and it also has ugly tax, short-term tax.
So that the thing that my sort of favorite thing to do is to find something that’s really cheap with no volatility in it. So the leap is very cheap relative to the stock. And that’s a small, the premium is a very small proportion of the stock price. So then a very small movement in the underlying gives you very big returns in the leap. And you can size it very, very small, too. So the premium might be 5% to 10% of the stock. So you’re only putting 5% or 10% of what you would put into the notional at risk and your returns can be pretty good out of that.
Meb: And so do you tend to target X number of positions, or is it…And how do you kind of find…what’s the process? Because we just spent this podcast talking about a very check-listed, quantitative rules-based process. And this is obviously a little more discretionary.
Meb: And so, like, how do you come about these ideas? Is there kind of a set three or four things you’re doing? Is it chatting with people? Is it screens? Is it what?
Tobi: Just to back up a little bit, the reason why we do it, we think that they’re…Basically, there are two ways in my opinion that you can beat the market. One of them is that, which is the quantitative approach, which is you’re just going to accept that there are some pain in some strategies and you’re going to not track the market for the most part. And it’s that pain that kind of keeps the returns over the long time, which is basically quant kind of investing, particularly in value. In special situations, you’re fighting things that for whatever reason people can’t buy them. They’re difficult to invest in or they’re there’s sort of unusual situations that you need some sort of specialized knowledge to invest in.
So I’m a merger and acquisition lawyer for a decade. I think that gives me some insight. Because I’ve sat in the boardroom with the directors. They’ve talked about these things. I have some insight as to how hard it is to get to that point, and then the likelihood of it continuing on beyond that. So the way that we look for, and this is two-fold, because we’re looking for they have to be undervalued. So that’s a screening. I use the Acquirer’s Multiple. I use other metrics to sort of find things that…because you can’t use it, Acquirer’s Multiple in financials insurance stocks, things like that. And we buy a lot of those. So we’re just looking for things that are genuinely cheap and that might occupy a small portion of the portfolio. That’s what we would call an acorn.
Meb: Let’s touch on that real quick because I don’t think we talked about that before. You said you cannot use it with financials or insurance? Does that mean, is it compared to the broad universe or you gotta compare them yourself or what’s the reason?
Tobi: They just tend to sort of fool the metric, just by the way that they, you know, that banks are highly levied and insurance companies have a lot of flight. And those things tend to just…They’re not, they have a balancing liability that’s not carried in the financial statements for insurers. So it’s sort of it fills the algorithm, or it fills the metric a little bit. So we don’t use it for financials in banks and insurance companies mainly.
Meb: This portfolio is, for the most part, long only? Is it equity? Or you do all sorts of…
Tobi: No, it’s equities and options. It’s not long only. Most of the positions have a sort of natural hedge because most of the positions are long short. It’s an arbitrage that we’re trying to put on. But some. So we will buy things that we just think are very, very cheap. But we would size them very, very small. They might be 1% to 3% of the portfolio. And we’re looking for some reason to make them a bigger position. So it actively hunting for that hard catalyst in them. So that’s one way of finding.
The other way is that the hard catalyst comes first. And then we sift through a lot of things where we sift through a lot of merger arbitrage, spin-offs, lots of things like that. And we’re looking for something that’s undervalued. And it has to be sort of undervalued in order for us to put it on, you know. So two things that we have on at the moment. We were long Yahoo, which owned a lot of Alibaba. And so you can short out the Alibaba. And you get exposure then to Yahoo, which owns, it’s got billions of dollars in cash. It owns Yahoo, Japan, it’s got a little legacy business, and you can hedge up everything else but that and sort of be long that…The reason that it sort of exists is this. That they have some tax on that. There needs to be some tax reform for that to really pay off.
And similarly, there’s another position, Sina Weibo. So Sina owns a big chunk of Weibo, which is Weibo, which is a China messaging kind of business. You can be long Sina and you can short out the Weibo. And you basically market neutral hoping that the two parts close up. So until a few months ago, that was wide and getting wider. And it sort of narrowed pretty substantially over the last few months because this U.S. activist has got involved with Sina, which hasn’t been a great corporate citizen. So the activist fund is trying to get them to try to get on the board. And that’s exactly the sort of situation I like, which is messy and complicated, and there’s some chunky value there.
Meb: We had another guest on here, Steve Shogren, who was talking about a similar, I think, it was the $0.10 Naspers.
Tobi: Naspers. Yeah.
Meb: Similar sort of idea, right?
Tobi: Very, very similar, yeah.
Meb: And I think Romek had that position on as well. I don’t know how it’s done, I have to look into it.
Tobi: It has been widening. It’s still widening.
Meb: Oh, boy.
Tobi: We haven’t put it on, but we’ve looked at it.
Meb: And to what extent do you use other activists and hedge fund managers as sort of a screen as well, kind of like, “Hey, these guys, you know, we follow. I think they’re smart. They’re doing this. Let’s look into it?” Or do you kind of just…
Tobi: I don’t do it on a formal basis, I don’t do it on a regular basis. But if I felt, like, there’s nothing that I love more than finding something that’s really undervalued. We did that last year. Right now, I can’t remember the name of the stock, but I remember the name of the activist firm benchmark. Electronics VHE is the ticker. And there was an activist firm involved. And we’d never got to sort of a big size in the portfolio, which is why I can’t remember the name of it. But it was very, very undervalued with an activist in there who was going to do all the sort of things that I would want to do if I got in there. So it’s an easy sort of decision.
Meb: How big did the positions get? What are you willing to let something grow to?
Tobi: So never sort of more than like 15% or 20% to grow to. I’d inception about 10%. Ten percent position, that would be something that we think it’s very, very undervalued and we can see a hard catalyst, like, that’s where about a certain as we can be on a position like that. Most of them are sort of 1% to 3% where it’s cheap, but we can’t figure out how it’s gonna resolve itself without some sort of act of God. And we’re kind of hunting for that thing trying to…
Meb: That was the best, the act of gods, that you weren’t planning on, that just got along.
Tobi: You get them on the other side.
Meb: Believe me, I know. So my worst trades were that. Anything in particular that’s getting you excited now? What do you think about? What are you researching any positions that you think are pretty interesting opportunities? You know, a lot of value guys, I hear both sides where there’s value fun shutting down, or like there’s no opportunities, then I’ll talk with other friends. They’re like I’ve had more opportunities now than I’ve ever seen. So it’s kind of interesting talking to different people because you get both camps. What’s kind of takeaway, you find some good ideas?
Tobi: I could fill two portfolios with ideas. There’s always…I can always find a lot of stuff today.
Meb: Simple ways with that. You just leverage two to one, you have two portfolios.
Tobi: Yeah, that’s true. But, you know, I think that it’s smart to then like get to that point and take the very best of the tip or fluorescent sticking one.
Tobi: But if, you know, I often look at the stuff that I didn’t do and that would have been a better portfolio to argue.
Meb: Well, that’s the classic. I listened to Rob Arnott podcast with Covell. And Rob was talking about, he’s like, the index deletions and additions. He said, “If you did a portfolio where he had the S&P, but instead of tracking the S&P, but you’d kicked out the stuff that got kicked out and added, if you just wait it a year, and then did it,” He’s like, “You’d be at the S&P, and I forget the number, but how many ever basis points by delaying that because the stuff that gets kicked out outperforms, stuff gets added underperforms.” He’s like, “So if you just delayed the rebalance, you would actually do better.” Anyway, so, all right. So what’s anything you can talk about that’s got you excited now?
Tobi: I mean, one thing that we’ve owned for a long time a short guarantee, which is this monoline ensures regional governments municipalities when they’re issuing debt, wraps the debt with…It guarantees to pay interest on interest and principal repayments in the event that the municipality can’t do it. The problem with the stock is that there’s always a municipality that they have insured that is in a headline. So right now, it’s of Puerto Rico. They’ve got some exposure in Puerto Rico. We owned it last year. We bought. We had it from the very beginning of the year, did very well last year. It was doing pretty well this year. The thing that we like about them is they serially buy back stock. They’ve bought back like 30%, 38% of their stock in the last couple of years.
Meb: Music in my ears.
Tobi: Super, super smart management. They have to be. It’s kind of like a listed hedge fund buying back its own stock. The problem that they’ve run into is that it’s hard to know how Puerto Rico unwinds itself. But that’s exactly the sort of situation that I like. It’s really, really ugly headlines, they’re really, really smart.
Meb: Well, you got Trump tweeting about it where he was like, unfortunately, the debt will have to get written down. Next day it opened up like down 20%.
Tobi: In my PA, I had somebody options in the links in it, too. So I felt that one.
Meb: The Trump. You know, it’s funny because I would put a lot of this, the ideas, and this is why I think the possibility that it has the potential to work and work well. I mean, I remember when I was younger reading a lot of books on distressed debt investing, and, you know, and M&A kind of in the same category of just too much headache for me, too hard arbitrage where these lawyers read through these 500-page documents and, you know, are figuring out how this all works. There was a great book back in the day that focused on the Marvel Comics bankruptcy and all the drama that went on there. And unintentionally, that was one of my best trades ever as a young man was investing in Marvel stock. But it was really only because I like the comic books and thought it was a good brand. It had nothing to do with anything else. But so much of this falls under that hard arbitrage where you’re like really working through some of these details that no one else is gonna do.
Tobi: Some of my best roads have been, I call that right for the wrong reasons, you get long marvel. You know, I wrote about this on Greenbackd, which is a blog that I neglect a little bit, but I ran pretty religiously back in the sort of the 2008-2009. I found this San Diego-based biotech with, like, 2 bucks in cash per share trading at about 70 cents. And there was an activist in there trying to get them to pay at the cash, which I thought was, you know, that’s easy triple. That’s a great idea. And I was in Australia at the time. I woke up one day and they’d been approved by the FDA for the drug that they were trying to get through. And the stock was up 10 times.
Tobi: So I went yeehaw.
Meb: That was an old, back on my biotech days, that was always a screen that was so simplistic to me, which was…And biotech goes through this about four year cycle where it’ll rip up 100% and then decline 50% and then rip up 100%, you know. And one of my screens was simply cash. Because so many biotechs would trade below cash values because they’re burning money.
Meb: But it always made sense to me to buy a basket of those. And then you have that potential upside of is there a positive catalyst?
Tobi: I have tested that. That is true. If you buy a basket of net cash biotechs, you’d do well. And we’ve got one enough. We’ve got one right now, AGTC, it’s a net cash burning biotech.
Meb: There was a lot of one of the early biotech quant books. It was called “From Alchemy to IPO.” And it was by female, I’m blanking on her name, scientist and investor. And I would love to walk forward a lot of those studies. Because a lot of them were simple, kind of like in fundamentals, and talking about over and under reaction, you know, buying, earning, surprises, and the drift forward afterwards. A lot of these anomalies that necessarily may or may not have been commoditized over the years. But hers was always you buy after a phase one or two or three approval. And the drift of the next year, it doesn’t quiet, the market doesn’t react enough yet. Anyway, I would love to go back and test. I’m sure there’s a bunch of biotech investors listening to this that probably have some quant studies to point to or don’t publish them for that reason, but always more ideas to look into. All right. Well, we better start winding down here. We’re gonna have you all day. It’s Friday afternoon. So I don’t want to hold you too long. What’s been your most memorable trade?
Tobi: Well, you know…
Meb: You could name a few. We can sit here for a while.
Tobi: You know, a great trade getting married to my wife, moving to the States.
Meb: Yeah, yeah, she’s not listening to this. Come on.
Tobi: No, she wont’ at all.
Tobi: Two kids has been a pretty good trade.
Tobi: Getting my American citizenship was pretty huge. I just agreed to pay tax in the States for the rest of my life so…
Meb: Oh, boy. Well, you might get a tax cut here coming up soon.
Tobi: So the last election, that was my first, that was my first presidential election to vote in.
Meb: No away.
Tobi: So that was an exciting one.
Meb: Yeah. I’m not gonna ask you. Keep going. All right, so most financial investing, most memorable trade, or investment. By the way, we didn’t even talk about this, Jeff. We finally, for anyone who’s still listening at this point, we finally went down and sat with our old guest, Van Simmons, who, if you, listeners, if you haven’t listened that episode, go listen. Really fun, rare coin dealer. But we just picked up a bunch of rare coins. Well, I’ve talked about our next Jeff and Meb show, what coins we got and why. All right, most memorable traded investment.
Jeff: Do that.
Tobi: In 2008, I’d stopped working as a lawyer and I’d started sort of sitting in this firm. And in order to, I stopped from…it was an Australian activist firm. So I was able to invest in the U.S. So I started doing net investing in the U.S. And so from that period in, like, the third quarter of 2008, I just had a basket of nets that I was spending too much time researching. I really should have just bought all of them. But their returns for that basket was like 250% over, like, nine months. The reason that I became a quant, because I started thinking, this is way too lucky and I’m not this good. I should go and look at what the entire cohort of these did. That entire cohort did 750% percent. So if I had just bought every single thing that I had looked at instead of like going through and finding an activists to invest…
Meb: Yeah, you were getting rid of all the hairy ones.
Tobi: I’d be retired, you know.
Meb: Yeah, well, if only you had the Acquirer’s Multiple back then.
Tobi: If only.
Meb: You know, it’s funny. We wrote an article, we’ve done this a couple times where, I think the name of the article and the link to it was called, “Is It Time to Do a Templeton?” Where I think there’s a famous screen in the Great Depression where he went and bought every, like, stock trading under $1 or something on New York Stock Exchange. Something like that. Very basic quant screen. I may be murdering this. But that was a screen. And so we did the screen in ’08 or ’09, and then walk forward, I forget how many years. We should update it. But it was just, like, it was absurd, the returns. Because it was the most hated awful beaten down stocks, and granted fair amount of them went bankrupt, out of business, but some of them just did, you know, the 10, 100 bagger sort of thing, the more than make up for it.
Tobi: It’s a portfolio protest. One of the things that I…Because I don’t I don’t use momentum when I invest. But I, you know, I backtest all the time. You can look at what it does. If you find that the market is getting completely destroyed, momentum inverts out of the bottom of a bear market. So what you wanna do is you find the things that are down the most, that are deeply undervalued. That will put some terror into you. That’s very, very frightening to do. But those things are like 10 baggers regularly at the bottom of this. Some O’Shaughnessy Asset Management Research on it.
Meb: Yeah, well, you know, the challenge there, of course, too, is, if you remember back to ’08, the conversation was, you know, could this be as deep and dark is the Great Depression, you know. Could stocks go down 80%?
Tobi: But that’s always the question.
Meb: Right, I know. And that’s the challenge. And so, you know, it’s so funny going back to CAPE ratio. But talking about valuation broadly is that we were having a conversation someone the other day and, you know. They were talking about is the CAPE ratio, and even in this conversation that, you know, is it getting higher or biased over time? And we said, “Well, by the way, if you go chat with investors in Russia or Brazil where these markets are down near five, you know, it’s kind of the opposite.” And so it you have these things that happen in markets that continually surprise you. And I think if we were doing this conversation 10 years ago with anyone, and you said there’s me a bunch of negative yielding sovereigns, everyone would be like, “Yeah, we’re right. What are you talking about?”
Tobi: What’s that mean?
Meb: Do we go through a nuclear, like, what happened, you know? And it, I think, surprised a lot of people. And stuff like Cyprus confiscating people’s cash balances, like that, you don’t think about that happening the modern day. Do you still pay a fair amount of tension to the Aussie market?
Tobi: Yeah. The Australian market is a little bit like the Canadian market, if anybody’s familiar with that. It’s heavily weighted towards financials just because there’s a few big banks that’s, like, 50% of the index. Then basic materials, which is mining essentially is another like 10% to 20% of the index. So, like, two-thirds of the index is basic materials and mining. Infotech is 0.5%. On a MSC, our world best is 13%. So it’s really, really underweight. So when you’re buying indexes, like Australia or Canada, what you’re doing is you’re basically taking a big sector bet on banks or on the economy when you’re doing that, or you’re taking a bet on basic materials, something like that. So I watch it all the time because I know it really well. I work as a lawyer there. And I invest in stocks there occasionally. But it’s just, there’s so much more variety in the States.
Meb: Yeah, well, there’s also a good example of when you’re in an international investor, knowing the local market, because there’s structural issues, too. For example, there’s some big incentives for companies to pay dividends there.
Meb: You know, and so that creates, if you’re a screener, and you’re just screening on international dividends, you’re gonna end up having more in Australia, or it’s gonna look better because the local tax laws and incentives to invest and…
Tobi: That’s right.
Meb: …companies is different. But that’s like that around the world. There’s a thousand of those different nuances, kind of like you mentioned with Acquirer’s Multiple on financials, all this stuff. I love Australia. We’ve been there a couple times. And it’s funny because the least attended speech I’ve ever given was in Sydney. And it was for an ETF conference. And they had me over, it was just when their ETF market was starting. And there was probably five people in the room, four of which were conference workers. And so some other guy. And that’s with fine me. I said, whatever, you know, I’d get to come to Australia for the first time. And then we did another one in Torquay. But since then, the ETF market there has exploded. And so, of course, they were like, “Hey, Meb, you should enter.” I was like, “Well, we got enough on our hands.” But how do we, you know, it’s really growing leaps and bounds there. But, you know, we live here in Manhattan Beach and there’s, like, my…it feels like a sister city of Byron Bay. Is it Byron Bay?
Tobi: Bryon Bay, yeah.
Meb: It feels very SoCal. There’s a lot of similarities. But I really wanna go back. I love Australia.
Tobi: East Coast Australia. I mean, I miss it because that’s where I’m from. I don’t really know West Coast Australia that well. And West Coast USA, very similar. I think it’s like, Australia’s like another weird state in the States. So I find it very easy, particularly California. I fit in here really easily.
Meb: All right. So Aussie listeners, if you have any more conferences that you need some speakers, let me know.
Tobi: And let me know, too. I don’t want to text… [crosstalk 01:19:24]
Meb: Well, yeah, you know, it’s gonna be a two-for-one special. So email us. Tobi, where do people find more information if they want to track your writings, your tweets, your books, your money management, all that good stuff?
Tobi: The acquirersmultiple.com is a great place to go. That’s got links to just about everything. We’re doing a little overhaul now so that’s going to be updated shortly. If you go on to Amazon, Tobias E. Carlisle, has all of my books up there. Buy them all, buy a few of them, leave a nice review. And I’m on twitter @Greenbackd, which has a funny spelling.
Meb: So talk to me…By the way, before we let you go, about the blogging, is it something you still do? How often are you still writing?
Tobi: I’ve tended to write the books just because I want a longer form to talk with. And we didn’t talk about the way that this book is written.
Meb: So let’s talk about it. I got nowhere to go. It’s right afternoon. Let’s hear it.
Tobi: The reason that I wrote this new book, and I’ve self-published this one rather than going through Wiley, who have been the publisher for the last three books. The complaint that I have always heard is that the book is 85, “Deep Values” is 85 bucks. That’s way too expensive. I don’t get any bigger cut out of that. I get more out of the Kindle version that I’ve self-published through Amazon than I do out of the $85 one. I didn’t set the price.
And the other thing is that it’s really hard to understand. I tried to write it as simply as I could, but I wasn’t sort of aware of this at that time. So I’ve recently discovered that there’s this way of measuring how complicated some writing is. There are a few different ways, one is called Flesch-Kincaid. The other one is Gunning Fog. And they all measure different things. But basically, they looked at sentence lengths, number of syllables, things like that. And it was basically developed for the Navy after World War II. They found that a lot of the enlisted men couldn’t read the manuals that were written by engineers. They couldn’t understand what was written in them. So they’ve found a way to write them, or at least score how they’re written. So this book, so “Deep Value,” I didn’t know this when I wrote it. More recently, I cut and pasted the entire thing into one of these online measures of these things. So it was written to a Grade 14, which equates to, like, 2nd year college, 2nd year university level, which is too high for most people who wanna read the book. And it’s sort of written…
Meb: You pretentious A-hole.
Tobi: Well, I thought I was writing it really simple. But it’s unintentionally. So if you sort of steeped in anything for long, and if you’re immersed in it, you forget what you’ve already been taught over the years. And for me, it’s the sort of all become one. My mom and dad are smart but they’re not stock market people at all. So they just say, “What any of these things means?”
Meb: Which is like any industry where you start using jargon, you know. If you’re a surgeon, if you’re finance, if your automobile guy, you know, you start talking about the coil and catalytic converter and everything else and, you know, nobody knows what that is.
Tobi: It’s shorthand so that they can speak to each other. So that they don’t have to describe the whole thing, like, you’re a man discovering it for the very first time. But I wanted to write something that they could read, that, you know, friends and family just so they can understand. So I got one of these Gunning Fog, Flesch-Kincaid online things where you can take what you’ve written and paste it into. And I did that religiously. So the entire thing is written to Grade 8. So if you read in school to Grade 8, you’re able to read this book. And I’ve defined every term that is not sort of plain English. I’ve turned it into…There’s a plain English description. If you’re a professional investor and you read it, and you think that my descriptions of these things as over simplified, send me an email with that in the subject line so I can delete it immediately.
Meb: Or they can put it through the reverse Kincaid and…
Meb: I have that extension in my word software. It’s called Jeff Remsburg. So I basically write in, like, Pig Latin. It’s my, riddled with spelling errors, grammar errors. By the way, the good news, I looked at this other day, I was writing in Microsoft Word. It’s gotten so good. I don’t even look at the…I just hit accept all on everything and then go back and edit it because, I mean, there’s also another app under the same kind of general that’s called Hemingway that does the same thing. You know that one? Where it’s basically like you use too many word, like short, simple, to the point type of writing. Anyway.
Tobi: Well, that’s one of the…When I was first learning about this stuff, there’s a web page and it shows you all of these famous writers and the level that they wrote at. Hemingway, he writes it like a Grade 4 level. Like, Hemingway, he’s got a Nobel Prize for Literature. So there’s nothing wrong with sort of writing at that level. Then you look at who else is down there. It’s like Dan Brown. He’s made $1 billion writing books.
Meb: That’s gonna be great Greenbackd articles. You’re gonna take the top 30 on the bestseller list, you know, maybe versus the top 30, I don’t know if there’s the top 30, like, Nobel’s…
Tobi: The best seller in valuation for “Deep Value,” which was, like, he sell a book every day, the best seller. And corporate governance that was, like, if someone downloads your book once in a year, that’s a best-seller in corporate governance.
Meb: Well, it was funny because I remember Goldman used to have a book on Amazon on Global Tactical Asset Allocation that was $800. Of course, I bought it and then returned it. Amazon, I think, still lets you buy books and return them.
Tobi: Don’t do that for my books, though.
Meb: So you can buy Tobi’s book and return it for a week and it’s totally free. But I was like these A-holes are charging $900 for this book. Are you kidding me? Anyway, and I think it was, like, I had a free version online. But I wonder if it’s still on there.
Tobi: Well, sometimes they’re set by algorithm. And I’ll just look at the other books and so they just increase at a cent at a time.
Meb: You know what I’ve found out? And we just recently fixed all this is that, and you may have to notice this, if you Google…or sorry, if you Google search or Amazon search any one of my books, and it’s fixed now, let’s say you typed in “shareholder to yield,” four separate listings would come up. And so some…And the books’ like 9 bucks. But the other three were like $40, $80, $250. And so as people in, I assume as other countries, but these scammers, they would copy everything on the page and then change the title by, like, one letter or symbol it out like a parenthesis at the end. And so basically, they were listing it is used but not the same book so that people, unintentionally, if they searched it, they would accidentally land on the page and then buy used copy for $50 instead of $10. So I found, like, seven versions of this. And, of course, I had like this huge about it. I was, like, “Oh my God. Is this systemic to Amazon? There’s all this fraud.” And I emailed a few people that work there and they’re like, “Oh, you know, it happens. But you just email this address and they’ll clean it up. And so, anyway, we should check it out for your books because it’s probably similar situation but…
Tobi: Mine probably don’t have the readership to sort of justify…
Meb: Well, the only reason I knew is because one purchaser emailed in. He’s like, “Hey, Meb, what the hell? You’re talking about this book that’s cheap and it’s $85.” I’m like, “I don’t know what you’re talking about. You send me the link.” And then…
Tobi: I think that’s how you know you’ve made it when someone’s trying to scam your book.
Meb: No, so the way that I paid for, like, my early 2000s or late college was half.com. Do you remember that website?
Meb: It was a used book website that first came out, probably still exists, eBay bought it, but there was a huge ARB opportunity for books. And so in some specific cases, there were a handful of Ned Davis books, who I love and we pay tons of money for, so I don’t feel bad about it anymore. But would regularly buy these books and they would go for $800. Because no one out…they were out of print. And I don’t know why they didn’t just print more. And they sent out. But I sold, it might have been dozens of them, you know. And for a young 20-something guy, $700 is like, may as well be, you know.
Tobi: That’s a year’s pay.
Meb: Oh my God. It was amazing. It’s like winning the lottery, too. Like, even, you know, that’s like finding money on the street. And so I basically cornered the market in Ned Davis books. But I’m sure that opportunity still exists today. I mean, I definitely anytime, I’m in an old used bookstore, I’m looking for that Seth Klarman, “Margin of Safety,” which I think still goes for a grand. Did you know that, by the way?
Tobi: Yeah, like everybody else, I’ve…
Meb: It’s free PDF online.
Tobi: Yeah, you can you can find a free PDF. I’ve never downloaded it. But I’m aware that it exists out there.
Meb: Seth. Poor Seth. He’s a big Puerto Rico debt holder by the way. He’s like one of the biggest.
Tobi: Pre or post the hurricane?
Meb: I think pre. Because there’s been a bunch of news stories about him. All right. Tobi, it’s been…thanks for coming out today.
Tobi: Thank you for having me.
Meb: Well, we’ll check back in a couple months. We have to have you back on. Checkout Tobi’s new book, the “Acquirer’s Multiple.” Listeners, thanks for taking the time today. We welcome feedback. Questions the mailbag at [email protected] Just reminder, you can always find the show notes and other episodes. There is gonna be a ton of show notes for this one at mebfaber.com/podcast. You can subscribe to show on iTunes. If you’re enjoying it or hating it, please leave review. And we love these gifts, you guys. Keep sending us. Thank you. Keep sending more peanuts, anything else you got online. Thanks for listening, friends. Good investing.