Deep Value Book

Deep Value - By Tobias Carlisle

I am reading Deep Value by Tobias Carlisle (Stock Screener - The Acquirer's Multiple).  I am about 1/2 through the book.  He devotes a lot of space to reviewing Greenblatt's Little Book That Beats The Market. It is a "very interesting" book.

On page 60, Figure 4.2 he shows how the magic formula has done from 1965 to 2011, so a much longer backtest than in Greenblatt's book.  And then he splits the two components of Greenblatt's formula: earnings yield and return on invested capital and see how each would do independently.

Return on capital by itself was unimpressive.  Basically on par with the markets.  Earnings yield by itself was stunningly good.  It actually did better than Greenblatt's approach of combining the two.  I know, I know - this is mind blowing stuff.  Almost feels blasphemous.

Carlisle does spend a lot of time thinking and writing about why this makes sense.  It does seem "anti-Buffett" as Buffett has mantra to buy great companies at fair prices, with "great" having a focus on ROE.  Carlisle argues that high ROICs tend to be temporary (as most companies do not have a wide moat) and they have a tendancy to revert to the mean.  But a high earnings yield also has a tendency to revert to the mean, which implies price going up (typically).

I can't really argue with the research in the book.  It is very thorough and looks at many different approaches,, (1) weighting by market cap, (2) excluding illiquid stocks and (3) using various exchanges throughout the world.  I could do my own back-testing based upon all my top 200 lists as I have calculated earnings yield and ROIC for 2500 stocks almost once a month for several years.

That seems like a lot of work, so may or may not do it.  My results are satisfactory, so i don't see the need for a material change of approach.  I may just start doing n EY only sort as well in my top 200 lists, just to see if anything interesting pops out.

Wheel of Fortune

His chapter after discussion of Greenblatt is called Wheel of Fortune.  I also found that it had some interesting parallels.  Basically it asks the question "does the market overreact?" to both good news and bad news for stocks.  This is starting to get into behavior theory, which I do believe is the way to really make huge money in markets if you master it.  I mean, what causes these manias like Bit Coin and how can you recognize them early?  You see stocks discussed in media and twitter all the time and they explode upwards for four or five days - I mean huge gains.  they are often an idea average people can relate to, like pot stocks or Roku or movie subscription service (like MoviePass).  I digress.

The work Carlisle reviews (by recent Nobel prize winning economist Richard Thaler) reviews returns of "loser" portfolios vs "winner" portfolio.  The loser portfolio is comprised of 35 stocks that had recently done very poorly and then you hold for three years. The winner portfolio is the converse, stocks that had had a great run and then you buy and hold for 3 years.

They are mirror images of each other, the stocks that had sucked, then did significantly better than broader market over next 3 years, while the high fliers (aka winners) did significantly worse.

I get it.  I know that it is difficult to buy a stock that has some sort of overhang or has crashed and burned recently.  Especially if you went through the crashing and burning.  Really, you often just want to sell the stock and never think of it again.  But Thaler (along with Carlisle) are telling us that is the worst thing to do (in aggregate).  These are stocks to be bought, not sold.  So (not a big surprise) our emotions are often our worst enemy.

ICON is a classic current example of this in the MFI world.  It is down 85% this year.  True, it may not recover - but a panicked sell probably is not the answer.  I own a oil & gas stock called EXXI.  It has gone from $30 to $5 this year (thankfully, I guess, I didn't start buying until $10). I am so tempted everyday just to sell it.  But I do believe the market overreacted as Carlisle says.

I also think this "winner" v "loser" plays a major role in my MFI Formula approach.

I do allow myself the flexibility to strike one stock from my screen list.  But then I use a random  number generator to pick my 5 stocks.  And I don't generally use the veto right.  This is because I worry about my own biases.  I may already own GME or PBI and am mentally scarred by their recent drops.  If I am just picking, I would likely not buy them for that reason, "heck, they always go down!".  But that my be exactly the time to buy them.

I am only about 50% through the book, but do recommend reading.  Carlisle does have a website (like Greenblatt's) that gives stock idea based on the Acquirer's Multiple.  I have not dug deeply into it, but I suspect it would give many of the same names if I sorted my top 200 list by EY.  That'll be a check for another day.