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Deep Value by Tobias Carlisle – Review & Summary
A comprehensive review and summary of Deep Value -Why Activist Investors and Other Contrarians Battle For Control of “Losing” Corporations, by Tobias E. Carlisle (affiliate link)
Book Review of Deep Value
I must admit I was underwhelmed with my initial viewing of the book. Maybe it was because I thought the price was high given the size of the book. Maybe it was because I had such high expectations that my first thumb through just didn’t hit the right buttons; I don’t know.
What I do know is my first impressions were absolutely wrong. Tobias Carlisle totally lived up to his reputation as a great writer (you will find his blog at Greenbackd ). Carlisle may be a quantitative investor but the descriptions of his writing are qualitative (interesting, informative, educational, scholarly, revealing, etc).
The title of the book could have been: “Why Everyone Should Be a Value Investor”. I’m certainly not saying that would have been a better title for the book. My point is that Deep Value makes the case, chapter by chapter, that deep value investing works.
Who should read Deep Value?: Anyone who believes they are a value investor, might want be a value investor, or is a value investing skeptic. After reading, you will understand why you are a value investor AND you will be a better value investor. It’s worth every penny.
If you want to buy the book please consider purchasing through this website. I will receive a small commission but you will get the same low Amazon price as anywhere else. Thank you.
Deep Value by Tobias Carlisle: Summary
The Icahn Manifesto – Corporate Raider to Activist Investor
In chapter one the groundwork is laid by describing how Carl Icahn evolved as an activist investor. Icahn embraced the Benjamin Graham belief that corporations who were not properly serving the interests of the owners (shareholders) needed to be confronted.
Icahn became an expert at gaining influence over, and drawing attention to, deeply undervalued companies. Icahn’s influence went far beyond the companies with which he was directly involved, including being the pioneer for modern day activism.
Contrarians at the Gate
In chapter two Carlisle provides the foundation upon which all deep value activists live: the true value of a company is not the same as the price. An activist attempts to buy shares of a company whose price is much less than its’ intrinsic value. This difference is known as the margin of safety in value investing.
The above are Benjamin Graham’s ideas. He stressed shareholder rights and options, including liquidation. He taught that the most important factors for consideration in value investing should be quantitative.
Trends tend to be qualitative and cause us to make errors in valuation. Quantitative data should emphasize the facts and ignore future expectations. Always remember that qualitative factors tend to revert to the mean (mean reversion). This can cause large valuation errors by those who choose to believe trends last forever.
Warren Buffett: Liquidator or Operator
The evolution of Warren Buffett philosophy as Graham’s star student to his own style of value investing is interesting. Buffett proved that there are different approaches to purchasing securities below their intrinsic value.
The Warren Buffet strategy is a long term strategy in search of high quality companies with sustainable competitive advantages. He believes a wonderful company can have first-class management with high rates of return. With the help of others, including his partner Charlie Munger, Buffett learned to embrace qualitative factors that Graham eschewed.
Related Reading: Quality Investing: Characteristics of Quality Stocks
The Acquirer’s Multiple – Fair Companies at Wonderful Prices
This chapter is the heart of Deep Value and my personal favorite. Carlisle dissects Joel Greenblatt’s magic formula explaining in detail why it works so well, but also why it is not a perfect valuation metric.
The most valuable half of the magic formula is the Enterprise Multiple. It uses EBIT (Earnings Before Interest and Taxes) or EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) and enterprise value to produce a measurement that identifies undervalued stocks, possibly better than any other metric.
Carlisle does an excellent job of explaining how the powerful forces of mean reversion can make some metrics less useful in identifying investable companies. One of my favorite quotes of the book is: “A company with great fundamental performance may earn a market rate of return if the stock price already reflects the fundamentals. You don’t get paid for picking winners; you get paid for unearthing mispricings. Failure to distinguish between fundamentals and expectations is common in the investment business.”
A Clock Work Market – Mean Reversion and the Wheel of Fortune
Mean reversion works on both company fundamentals and in markets. High growth rates in companies do not endure. Market forces such as competition eventually move growth rates toward the mean (growth rates fall). In the markets overly optimistic investors pay high earning multiples (high prices) for stocks of companies because they expect high growth. The earnings multiples also mean revert (multiples decrease). Therefore, mean reversion works in two forms to reduce the prices of high growth companies.
The evidence is clear that undervalued portfolios of “loser” stocks outperform in the long run. Baskets of companies with depressed earnings tend to revert to the mean (earnings rise). In addition investors value these company stocks at low earnings multiples that also revert to the mean (multiples expand as earnings rise). Therefore, mean reversion works in two forms to increase the prices of fundamentally undervalued stocks. This is why value stocks outperform glamour stocks in the long run.
Trading in Glamour: The Conglomerate Era
Chapter 6 explores the Conglomerate Era which provides some pertinent examples of how investors think and value stocks. Carlisle cites some of the research that explores why investors favor glamour stocks. Over and over, investors “fail to take into account for any possibility of mean reversion when mean reversion is the probable outcome”.
Catch a Falling Knife – The Anatomy of a Contrarian Value Strategy
This chapter makes a strong case that stock valuation is the only important factor in stock selection. The evidence demonstrates that buying the companies with the poorest historical metrics (earnings, growth, etc) and prospects end up outperforming all other stock categories.
Investors have a tendency to overestimate glamour companies and therefore overvalue their stocks because they ignore mean reversion. At the same time, investors have a tendency to underestimate (or overlook) troubled companies and undervalue their stocks.
These facts provide many opportunities for value investors. It also produces an environment that is favorable for a simplified approach that concentrates on finding deep value. In 1976 Benjamin Graham advised:
“What’s needed is, first, a definite rule for purchasing which indicates a priori that you are acquiring stocks for less than they’re worth. Second, you have to operate with a large enough number of stocks to make the approach effective. And finally, you need a very definite guideline for selling.” (page 146)
The Art of the Corporate Raid – A History of Corporate Violence
Chapter 8 begins with a short history of corporate activist T. Boone Pickens, Jr. and how he looked for companies that had undervalued stocks due to poor management. He was just one of many activists that began fighting for change in the 1980’s.
The concept was to cause changes in policy, management, or ownership in order to unlock hidden value and close the gap between intrinsic value of the targeted company and the price of its’ stock. Campaigns included strongly advertised proxy fights, lawsuits, takeover bids (hostile and friendly), and public operations to criticize and/or change management.
How Hannibal Profits From His Victories – The Returns to Activist Investment
In Chapter 9 Carlisle examines the returns for corporate activism. It is clear that investors such as Ichan have made extraordinary profits from the endeavors. But has it benefited the market or society as a whole?
Research and studies are presented that validate Benjamin Graham’s thesis that active investors should act as owners and press the company to act in the best interest of shareholders. Activist activities have improved the operating performance and boosted shareholder prices over the past several decades.
Applied Deep Value – How to Identify Deeply Undervalued, Potential Activist Targets
Empirical evidence supports the Graham arguments that portfolios with the most unappealing companies have such low stock prices that they offer the best returns. While portfolios of high growth companies are expensive and offer lower long term returns.
The best value is often found with the worst of circumstances. Deeply undervalued stocks are often found during crises, have falling earnings, and tanking stock prices. That doesn’t mean the companies are necessarily in distress. Often times they are flush with cash that is being poorly allocated and/or mismanaged.
Failing businesses, poor management, and unpredictability often provide the most promising investment opportunities. Deep value offers the best risk/reward ratio for investors willing to go against intuition and what is normally accepted by the investment crowd.
Mean reversion is a powerful concept that works in favor of undervalued stocks and against overvalued stocks. The contrarian approach is to look for mean reversion in both fundamentals and valuation.
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