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STEPHEN CLAPHAM: Hi, I'm Steve Clapham. Welcome to The Big Picture. This is the first interview I'm going to be doing in a series of interviews with value investors.
My first guest, I'm delighted to say, is Tobias Carlisle. You will have heard of Tobias. He runs The Acquirers Podcast, he runs the Acquirers Funds, and he's written a book, The Acquirers Multiple. Can you guess a theme here? I'm really excited, looking forward to talking to you. Welcome, Tobias.
TOBIAS CARLISLE: Good day, Steve. Well, thank you. Really happy to be chatting to you again.
STEPHEN CLAPHAM: It's been a little while. I was looking at your biography and you started out as a lawyer in Australia. And now, you're a value investor in California. How did that happen?
TOBIAS CARLISLE: I started working as a mergers and acquisitions lawyer in April, 2000, which was the very top of dot-com boom. I don't know if I saw an up day. I might have started on the first days that it started falling over. And I had gone in thinking that I was going to be doing all of this venture capital type work and working with entrepreneurs. And the world looked very optimistic at that point. And then when it collapsed the landscape changed very dramatically, and it became it became more mergers and acquisitions rather than capital raising and that sort of deal.
And there were liquidations. And we saw the reemergence of these corporate raiders from the '80s who would be trying to get control of these little-- a lot of the dot-coms raised money with sort of terrible businesses that were losing money, and the activists just came in and tried to get control of the cash. They'd stop the business and then they'd either liquidate the company or try and build a daisy chain of these-- sort of use that as a vehicle to acquire other things.
And I just found it a really interesting game that they were playing. I'd already read Buffett's letters, and I'd read Security Analysis. It was sort of difficult to understand what they were doing in the context of Buffett's writing. Because Buffett says he likes wonderful companies at fair prices, and he's got all of these rules for determining whether a company is wonderful or not. And these things definitely weren't wonderful companies. But I did remember that Graham had written in Security Analysis this chapter 28, which was about the liquidation value and the relationship of management and shareholders. So I went back and reread that, and I thought if this ever comes around again, that there's this opportunity, I'll go out and try and do some of this stuff myself.
And so it took a long time. And in the interim, the next time it came around was 2007, '08, '09. But in the interim, I got transferred by my firm to San Francisco to work on technology M&A. I wish there was a reason-- there was there was quite a bit because there was no capital raising going on.
The only thing that had happened that was sort of interesting, I got there in 2004. Google had just gone public with a reverse dutch auction, which was really unusual. It was sort of the only IPO that was interesting that year. Anybody in Silicon Valley, all they were trying to do was get acqui-hired, which is basically, you come up with like a Mission burrito locator using Google Maps, then they come and buy you for a million dollars. They're basically hiring you to work on their projects.
So there wasn't actually much going on. So I went back to Australia to work as general counsel for a telecommunications infrastructure company that was listed on the stock exchange that did very well. And I took my then girlfriend, now wife, with me, who I met in San Francisco.
That business did very well, it got sold. I went and work for a hedge fund that was activist. Learned some of the tricks, and then started my own partnership in 2010 in Australia. My girlfriend and I decided to get married. We're now living in Los Angeles, about five minutes from her parents because they've got three kids and her parents help with the kids. And that's why I'm here.
STEPHEN CLAPHAM: Oh, cool. It's quite funny, isn't it, that you started at the top of the boom and you ended up with a value investor. Do you ever look back and think, if I'd only been a year earlier, I might not have got that bent and I'd be in a different position today? Tell us a little bit about what you're doing now with the value ETF.
TOBIAS CARLISLE: Well my life would be a lot better if I'd started a little bit earlier. If I'd hung around in San Francisco for a little bit longer. I've missed it twice just by that much. Value investing, I think-- and, you know this because I know that you're a deep fundamental forensic accountant analyst type value investor, as am I. I think that it's one of those things-- I think Buffett describes it as an inoculation, either it takes, or it doesn't. It's kind of genetic. You just-- if you believe that there are some sort of logic and rules to this game, and I think that identifying these things that are undervalued either appeals to you or it doesn't.
I hunt for things, basically, that are deeply undervalued, and where the business is a little bit depressed too, where there's some possibility for the business improving. And so where Buffett might hunt for wonderful companies at fair prices, I'm looking for fair companies at wonderful prices. Basically that means that I'm prepared to buy cyclicals and other things like that.
Part of being a value investor is buying these things when they get really beaten up. I have two ETFs. The first ETF is called The Acquirers Fund. And the ticket for that is ZIG. It's a long, short, large, and mid-cap US listed fund. So the reason that that's appropriate, I think, for that strategy, there's a lot of private equity and activists in that mid-cap and above range. And those companies tend to be pretty well capitalized. They've got professional management. When they go wrong there's either professional management to fix it or there's private equity and activists who will come in and kind of bump these things back into to where they should be.
What that means is that they don't get-- they do get really undervalued. Now's a good time to be looking for them because I think there's a lot of really undervalued stuff in there, but I think that they return to value pretty quickly. The other fund that I manage is called the Roundhill Acquirers Deep Value fund. It's a small and micro fund, the ticket for that is DEEP. D-E-E-P.
It's hunting around in small and micro. So the definition of that might be sort of up to about between $300 million, or between $75 million and about $2 billion. And they tend to be earlier in their paths. Often they're just companies that for whatever reason can't grow out of that. Although at the current time, there are a lot of companies that have been very big that have just been beaten up so much they've been compressed down into small and micro. I'm kind of astonished at some of the names that I find in it now. But they're the kind of companies that I look for. They've got great balance sheets, they're generating free cash flow. Management is doing something about it for the most part, they're buying back stock. And that's what you want.
If you're a passive investor along for the ride, you need to be confident that management is going to do the right thing. And that's to take advantage of the undervaluation. That way you kind of get all of it, all of the value is concentrated down to the shares that you hold. And I think that over time it will force them up. So that's the two funds, and that's the strategy.
STEPHEN CLAPHAM: It's interesting what you were saying about private equity coming in and buying these things. I listened to a podcast that John Hampton did with Grant's Interest Rate Observer. It was May 2018 and it struck me because what he was saying was that there are loads of $500 million, roughly, market cap companies around. And if you were the CEO of one of those companies and it was a good business, and it was cash generative, and all the rest of it, private equity were beating your door down because they've got so much money on the sidelines and they're desperate for that sort of vehicle. And if you are running that sort of business, well where are your incentives? Here's your incentives, you get the opportunity to cash in all your chips, cash in all your options, and you get the chance to go again. And his argument was that the stuff that was left was the stuff that private equity didn't want.
Have you found that perhaps the quality of some of these companies isn't what they would have been? And have you seen any work done on how many of these businesses have been taken out by private equity?
TOBIAS CARLISLE: So there are two parts there. 2018 I would agree that was probably-- the market probably had been quite picked over for value by that point. And the stuff that was left was a little bit uglier than it would be in the usual course. And I think that has been reflected in the fact that since 2018 value has really not worked very well, it's gone backwards.
But I think that we're now at a different-- now we're coming up on the end of 2020. It's three years, almost, of under-performance for value. And when I look at the value portfolios now I think that they are unusually high quality. They do have very good balance sheets. They do have lots of free cash flow, and they do have management teams that seem to be doing the right thing on behalf of shareholders. So I would agree that that was the case in 2018, I don't agree that that's the case now.
STEPHEN CLAPHAM: I mean we could be at the point where we're going to get bailed out and we're not going to be the pariahs at the party. Nobody, I mean obviously none of us are going to parties now because you're not allowed. But if you were going to parties now and you said you're a value investor, people wouldn't want to talk to you. Interestingly I saw that AJO Partners, Ted Aronson closing down $10 billion value firm, which I guess had been significantly larger a couple of years ago. Had a bad performance this year, closing down.
Are these the sort of signals that we should be looking at and say, well actually, this is exactly the point we should be starting to get interesting because this is the contrary signal?
TOBIAS CARLISLE: Yeah. Well, value guys love contrarian signals, and that's definitely one. As sad as it is to see competitors shutting down and leaving, it's ultimately better for those who remain. And that's true of the companies that I invest in, and true for the industry as well, for value guys. I think about value-- I think about investing perhaps a little bit differently. I think when you look at the stock price, basically the stock price at any given time is just the marginal seller and the marginal buyer. And they're tied together in-- they're temporally tied together, tied together in time.
So it looks like there's some sort of trend, something going on in the stock price. But really as an investor, you can ignore the trend. You can take advantage of the price when it's in your favor, you don't have to sell it when it's not in your favor. And at every point, every price gives you a different expected range of returns. And so there's a point where I can calculate for any given price what I think the forward return will be based on what the company has been earning over time and will continue to do in the future. And that's a combination of yield and growth. And then I can, on top of that, I can-- I don't have to do this, but I can also look at, what if there's some mean reversion in this price? What if this undervaluation goes back to being a more normal valuation? And so I think about those two things, there's mean reversion, and the return we're offered.
The mean reversion part is the part that often makes some value investors-- there are lots of investors who don't like to think about it at all. And so you can ignore the mean reversion part and just look at what's the expected return for buying at this price that's offered to me in the market. And I think that we're at this point now where, when I look at the portfolios for value, those portfolios have a better yield and better expected growth than the market and very growthy portfolio.
So in the interim the stock prices can do whatever they will. But over a sort of three to five year period, I'm reasonably confident that these portfolios will outperform both the market and the very growthy stocks. So I think that that's the signal that I would look for.
STEPHEN CLAPHAM: Yeah. I mean it's a very good point you make if you take a three to five year view, that you've got stocks which are priced more cheaply than the market and have got growth as good as the market. So that should come through. But the problem is that for thousands of professional investors, many people watching this I'm sure included, you've got a problem haven't you? Because value hasn't been working for so long that you've kind of got to stay in business for the next three to five years. And I think a lot of people are being tempted into some of the growth stocks. How do you resist that temptation?
TOBIAS CARLISLE: Well I'm a student of history. I'm an avid student of history from the classics through to-- there's a great study by a friend of mine, Michael Semenoff. He looked at 200 years of value. And so we've got Fama and French, of the famous factor investing. Ken French runs a data website. It has data going back to about 1920. The French data is sort of the standard in the industry. Between 1875 and 1920 there's another set of data by Alfred Cowles he had the Cowles Commission. He famously used the punch cards to try and determine if there were any investors out there who had any skill, and concluded that there weren't.
But Benjamin Graham, I think that this is the case, I'm not entirely certain. I think Benjamin Graham-- because he refers to some data that he looked at-- Benjamin Graham went and did a back test through the Cowles Commission data, and he found that these low price to book value stocks had outperformed over that 1875 to 1920 period. And then there's some further research which is-- it's really a lot patchier than the modern data, but we can go back to 1825 and we can look at annual reports and dividend yields as a sort of proxy for value because the financial information that they published was scanty compared to what we have today.
And so even looking back that far, there is some indication that the companies that had the higher dividend yields, which would be the value companies, tended to outperform. So we can put all of that data together and look back over 200 years. And we can see, for one thing, huge depressions have occurred more regularly than it might suggest only looking since 1920 because you only catch that one in 1929. There were three. There's the long depression, which ended in 1904, and the forgotten depression.
And so when you look at what value did through those periods of time, the last time value drew down like this was 1904. And when I say drew down, it was it under-performed the growthy side by about 59%. The interesting thing for me, like 1825-- what was happening in 1825? Well that was the beginning of the Industrial Revolution in the US. And that was Commodore Vanderbilt with his steam ships. And that was a little period of growth and optimism. And it was one of the times that value under-performed. And then there was another one in 1841, that was the introduction of the telegraph. That was the first information technology revolution. Because before then, information had traveled from, say England, to New York as fast as a sail ship could be blown across the water by wind. And all of a sudden it could be transmitted almost instantaneously via sub-sea cables. And that was another period of under-performance for value.
So when I look back, there are these very notable periods of under-performance for value, typically tied to very rapid advances in technology. And of course, the one in the 1920s was probably through the introduction of the motor vehicle and the creation of all of the infrastructure for cars and gas stations and so on.
I think we're just going through another one of those now. These things happen periodically. I don't think you can get too upset about them because if you're a value investor, what you're relying on is that the market is not rational. So you can't get upset when the market is not rational for you. All you have to do is think about it in sort of longer terms. The market has, every other time, returned to rationality after a period of time.
So that's how I think about it. I'm pretty confident that the market will return to rationality. Even if it doesn't, the stocks that I hold on a yield and growth basis, they don't need any multiple re-rating. I'm very happy to hold them here where they are. Because I think that I will get a sufficiently good return over the next three to five years, however the market treats these companies.
STEPHEN CLAPHAM: And does it matter how the market treats the big growth companies? Because it's not an argument I necessarily subscribe to, but there is an argument that says it doesn't matter what you pay for some of these things, whether it's an Amazon or a Google or whatever. That their prospects are so fantastic that you can forget about the multiple and just pay up. And if, I mean I don't happen to believe this, but if people believe that and it went on and on and on, you might do well from your businesses, but you might still massively under-perform these other growth companies. Does that keep you awake at night?
TOBIAS CARLISLE: It's always been true that the very best companies, the very highest growth companies, are always expensive. And that's what keeps people buying the very expensive companies. Because they know that in the very expensive companies, occasionally you can pull out a Walmart or a Microsoft, or an Amazon. Those things, they just don't ever get cheap because everybody knows it's a great business, and it's growing so rapidly.
As a value guy, to see somebody else performing well, that doesn't hurt my feelings at all. I wish everybody the very best in this market. I would caution though, that there are many fewer of these companies that are going to do that than they are priced to do it right now.
So I think that for every Amazon out there are plenty of other JDS Uniphase. There are lots of other companies that, if you look back at the dot-com there are lots of these companies that-- they all looked like they were going to be Amazons. And even Amazon drew down 90% on a few occasions through there, so you had to be-- you needed needed a cast iron gut to kind of ride that roller coaster.
I wish that I'd studied them a little bit more closely. There probably would have been times when Amazon was buyable for a value guy. Certainly, Google has been buyable for a value guy. Microsoft was very buyable in 2010, 2011. I remember distinctly, value investing congresses being pitched Microsoft.
I thought at the time, this is a very big, old company. why look at something like this when there are other, easier opportunities around? Little did I know that they were going to transfer to a subscription model SaaS business and absolutely shoot the lights out. That's a mistake that's 100% on me.
STEPHEN CLAPHAM: It's hard predict, though. Hard to predict. It's interesting what you say because Amazon fell 90%