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The Magic Formula vs. The Acquirer's Multiple | Joel Greenblatt vs. Tobias Carlisle

Jan 25, 2022
hey guys tom here from investing tom youtube channel welcome back to the channel if you enjoyed todays video please like subscribe and that way you can watch future videos too so in todays video we are going to see two books so first we have the little book that still beats the market by

joel

greenblatt

which contains his very famous

magic

formula

and we have the taker

multiple

by

tobias

carlyle which takes a slightly different perspective on quantitative value investing and actually has better returns than the

magic

formula

in this book, so they're both quantitative value investing books, in other words, they have a formulated approach to value investing, not necessarily, um, they spend time researching individual companies and doing a Kind of a fundamental analysis like Warren Buffett or a monastery would do. sort of a screen or a formulated approach that brings together a basket of stocks that meet certain criteria to invest in those stocks and more so once both strategies have beaten the market, I want to go into my thoughts on both and explain to you the strategy each of these approaches and just giving you my opinion on everything, so I hope you enjoy it.
the magic formula vs the acquirer s multiple joel greenblatt vs tobias carlisle
I definitely highly recommend these two books. In fact, I read the

multiple

acquisitions before I read the little book that still beats the market. If I were to do that again I would do it the other way around so I would probably read

joel

greenblatt

's book first and then the inquirer is multiple the reason for this is that the multiple of

acquirer

s actually compares quite a bit to the magic formula of Joel Greenblatt in this book, so if you're looking to read any of these books, I'd pick Jolgren, though first, uh, then the

acquirer

s. several they're both really good um easy reads relatively short I think they're both around 150 pages so with all that said let's get right into the details of what each of these strategies entail huh and l Let me give you my take now first off let's talk about joel greenblatt's little book still outperforming the market now if you don't know who joel greenblatt is he's actually written several books on value investing at this point uh he's a teacher. on the subject and, um, he's had a phenomenal track record, so in the early part of his career, he was much more focused on special special situations, mergers, uh, spin-offs, bankruptcy, investment, uh, all this Kind of things that, um, created special opportunities for uh. the market mispriced certain securities and ended up with a phenomenal record rate of something like 50 annualized annual returns, which is probably the highest record return I've ever heard of, even if it was over a reasonably long period of time. short. not over several decades as we see with Buffett and then he transitioned to a more quantitative approach, which is exactly what he talks about in this book and is one way that he sees that the average age investor can design his portfolio in a so that it can beat the market and generate very good returns in the long run.
the magic formula vs the acquirer s multiple joel greenblatt vs tobias carlisle

More Interesting Facts About,

the magic formula vs the acquirer s multiple joel greenblatt vs tobias carlisle...

The book also contains a lot of off-the-cuff jokes which, even though I'm not a parent, I am a huge fan of. a dead joke so if you like that kind of stuff that's on here too now let's talk about the magic formula so the magic formula basically has two components and range actions essentially in two different metrics so the The first one is Earnings Yield and I'll put the formula for that on the screen here and interestingly the Earnings Yield Formula is pretty similar to what Tobias Carlyle Tobias Carlyle's Multiple Acquirers also looks at but that's the first criteria as the profits produce the second criteria is a return on equity now basically what each of these metrics are intended to do first of all earnings performance simply looks at how cheap a company is based on last year's earnings, so if last year's earnings were t dollars and you can buy the stock for a hundred dollars that's an earnings yield of 0.1 or 10 so basically Before you're ranking all the stocks in the universe this formula looks at what has the highest earnings yield the other thing is you see um with return on equity it's basically a metric or an indicator of the quality of the business now we hear all the time to people like Warren Buffett and people who follow Warren Buffett uh talk about things like wanting to have a business with a high return on equity higher return on tangible assets high return on equity all that kind of stuff and this is one way where joel greenblatt is doing the same type of thing and is really looking for high quality businesses businesses that probably have an opportunity to reinvest their earnings um it's at high rates and continues to grow shareholder equity over time so So those are the two things the formula looks at, it essentially ranks the shares from one to how many shares there are. on the list of both metrics and combines your score on each, so for example if a company had the best earnings performance across the screen, it would rank one and let's say it had the 19th best return on equity across The screen would have a score of 19 from which you combine the scores and you get 20 and basically you're trying to invest a bit like golf and the companies that have the lowest score so that the ranking is ideally high on both wins. and the return on capital and over time that has produced very good results and joel greenblatt's reasoning is basically that you're buying above average businesses in terms of business quality with the return on capital metric there and you're buying them below from average prices and that's basically what a lot of value investors are trying to do and it's worked really well so I'll put some screenshots here or some images from the book just to show you some of the returns that this particular mule has generated and that's what joel greenblatt is talking about so let's talk about multi-acquirers now

tobias

carlisle

the author of this book puts out some great content on youtube and also on his podcast is the equivalence podcast so i definitely recommend checking out i certainly am a regular listener to all of those so um toby was born in australia he actually started out as a lawyer and his first kind His introduction to investing was, um, both through his legal practice and also seeing Australian investors actually invest. in these failed businesses that came out of the dotcom boom and subsequent bust and he saw these investors buying these businesses that weren't making any money that basically had no business but were still coming in and taking big stakes in these companies and he was sitting there trying to figure out why um and looking back now it's obvious you know these investors were ac the activists that were coming in and very ben graham style and basically liquidating the companies and taking the cash out of that business they didn't really care the underlying quality of the business, they were taking out the cash that was in there because they could buy shares in that company for less than the cash per share they had, so um, that's where toby started, he had sort of very successful net style investments, uh, during the financial crisis, it actually returned hundreds of percent over the next few years, um, and p He went on to write the multiple of aquarius after that, so basically what this book does is it takes us through, um, some slight variations on the magic formula that Joel Greenblatt talked about, so one of the things Interesting that toby came back and what he did was he retested the magic formula and found that it worked just as Joel Greenblatt found that he found that it didn't work as well as Joel Greenblatt had described um in his book The Little Book That Beats the Market but still It worked really, really well though and beat the market uh one of the cool things that toby actually figured out was if you completely remove one of the components of the magic formula if you remove the enterprise grade component and he just zeroed in on badly beaten cheap stocks, regardless of what the return on equity is, actually had better long-term returns than the magic formula now the name of the acquirers multiple originally comes from a book that Toby read and is essentially a metric that activist investors would tend to look at again when they're looking at potentially acquiring a business and seeing how cheap it is and that formula is ev to ebitda or enterprise value to earnings before interest tax depreciation and amortization um and that basically means you're looking at how much money the business makes compared to the enterprise value of that business and toby is fir first one he really explained very clearly through from this book why we should focus on company value and that's actually a key change i made in my own investing is evolving from this market cap approach i guess originally it all started is per share then you look to the whole company and you look at the price through the market capitalization and then you start to get a little smarter and inco You take debt and cash and then you focus on enterprise value so thank you toby for that he was definitely the first person to explain that to me very clearly and you'll often hear me talk about enterprise value on the channel and that's one of the reasons The main reasons why the key question toby has to answer in this book is why the heck do you forget about business quality and just focus on this multiple metric of cheap acquirers uh it becomes better returns and it really comes down to one core idea which is something called mean reversion now mai Reversal is basically the idea that, over time, companies and the prices that people pay for companies, uh, go back to the mean so you can go through these periods of time when companies have a really high return on capital, a very high or very low return on invested capital. really low return on capital and return on invested capital and what happens is if you plot those metrics for those companies over time, the companies that have those really high returns on capital tend to come back to a really low return on capital capital more average normal over time and the companies that were very underperforming actually tend to improve and move more towards average over time and this is really a reason to buy huh and toby's opinion , those really discounted companies can produce excess returns as you often buy these really beaten up.
the magic formula vs the acquirer s multiple joel greenblatt vs tobias carlisle
First of all, the companies are extremely cheap and focused on business value. You are buying companies that have a lot of cash and not a lot of debt. or they're well funded and they're in a position to, um, I guess get things back on track and over time this mean reversion and buying really discounted businesses has produced frankly spectacular returns now depending on kind of size market capitalization and the universe of stocks you focus on, whether they're stocks below $100 million, for example, or stocks above $1 billion, whichever way you split the market, um, regardless of how you do it, the multi-acquisition approach has actually performed very well in the ballpark something like 18 per year compounded from the mid-'70s to around 2017.
the magic formula vs the acquirer s multiple joel greenblatt vs tobias carlisle
So, amazing returns if you compare that with the market again i'll put some screenshots or some photos here of the charts you'll see the outperformance is just ridiculous and if you understand the math Behind the capitalization, you know that even performing better than one or two percent of the average market over a long period of time can result in as much as double. e or a triple and what you get at the end depending on how long you're investing so having a massive outperformance like this can really do spectacular things for your return on investment and for your net worth over time so that was a brief summary of both the little book still outperforming the market and the multiple of acquirers.
I highly recommend you check out both and I just want to spend a couple of minutes talking. I guess how this has or hasn't impacted my own investing now um both joel greenblatt and toby carlyle basically say they know we're going to go through periods of time where any of these formulas just don't work um and it's really the fact that they don't work what keeps them going for a long time. time period which sounds a little weird but hey if you take something like the magic formula for example you're buying above average businesses at below average prices and that's fundamentally always going to work in my opinion then When you go through a period of time where the strategy is actually not as successful as long-term history might suggest, manypeople basically abandon that strategy and you're seeing a lot of that.
By the time people suggest that value investing doesn't work, um, you know Warren Buffett has lost his touch on all this kind of stuff and what that means is you start getting these widening spreads between the really cheap stocks and really expensive ones. stocks and again listening to some of toby carlyle's work we're in a gap as wide or as wide as we've hardly ever been and it means for people who can really stay the course with um these undervalued companies you know write strategy and investment of value generally means that the payoff is likely to be higher over time because if everyone knew it worked and it always worked, the opportunity would be arbitrated and the price would go up to reflect that it always worked and then it wouldn't work anymore, so that the fact that you go through these periods of underperformance and periods of overperformance, frankly, is a good thing if you're someone who wants to pursue this type of strategy long-term because it means that the opportunity is always going to be there now in terms of how this has impacted my personal investment.
I guess the first thing I already mentioned is having a much broader focus on enterprise value. that's something I've been in for at least a few months if not a year at this point it's really having a stronger focus on business value the second thing is I'm often asked how do I evaluate stocks or do I evaluate stocks . not at all and I almost always say I really don't because I'm usually looking at stocks of things like Thursday filings nf uh just general news coming out to keep up with companies already on my watch list I also run this channel from youtube and i work full time and try to train for weightlifting and stuff like that so i dont really have a huge amount of time in the day to run screens and research actions as much as i would like but frankly thats something tha ha changed a bit since reading these books so i started concentrating on looking at the acquirers multi screen which is something you can access for free.
I think on Toby's website there may be some restrictions on the terms. of the market cap range looks like you see in the free version but you can go ahead and see joel greenblatt has i think it's magic formulainvesting.com where you can go and look at magic formula stocks completely free on his site um and basically that just opened up this whole new universe of individual companies to look at, so one of the things that you can often get with these kind of basic screens is you get these weird businesses that maybe had a really good year or um, there's something weird going on that means they look really cheap on the surface of things, maybe based on last year's earnings, but they're not necessarily that cheap based on what future earnings will probably be, so which puts together a screen and sort of a universe of stocks that I can start looking at and see if it's outlier stock or if it's really cheap and it's been a great resource for me to help get more stuff on my desk to keep digging and keep digging and you'll probably be surprised by some of the stocks listed there you know Apple even got listed in the buyout multi screen as one of the cheapest stocks in the market only three or four years ago that's right around the time Buffett was buying and you know it's basically tripled since then so I'll definitely keep keeping an eye on some resources and they're also great reads so I recommend you check them out and that's basically all. for me today so i hope you enjoyed the video if you did please like and hit subscribe if you've read these books so you get some ideas on multiple of acquirers and joel greenblatt's magic formula certainly let me know I'd like to hear your thoughts but that's it for me today so I hope you enjoyed the video please like and subscribe and I'll see you in the next one cheers

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