MI Rewind: A Rational Approach to Investing w/ Tobias Carlisle

25:35But value did very well in Japan. If you were just a simple, you bought price to book, price to earnings, price to cash flow, just buy the cheapest stuff, buy and hold it for a year, rebalance the portfolio at the end of the year, you've actually generated really, really good returns in Japan over that period because that mechanism of buying too cheaply and then selling when it gets a little bit more expensive and then rebalancing back into cheap stuff and selling as they go up a little bit, as they get close to the mean, that little bit of mean reversion. That's been a way to generate returns in Japan, there's a reasonable chance that that is what happens here.

26:10I'm not relying on that. I don't need any sort of multiple expansion for my portfolio to work because I can do another assessment of value in the portfolio, which is a little bit like I referred to before, but you get a dividend yield. And then I can look at the return on equity and the payout ratio for a company. So I know roughly what it's reinvesting in itself. And I can look at the rate that it's likely to earn. So the return on equity tells you what it's going to earn on the reinvestment, and that gives you the incremental growth over a year. And with that dividend yield and that incremental growth, you can generate an expected return for stocks.

26:43And I think that the expected return for value is higher than it ordinarily is right now, even ignoring the likelihood of the multiple expanding to get closer to the average multiple, which might generate some additional return, but it's unnecessary. It's purely an expected return. So I think that But I'm sort of in two minds. On one hand, I am nervous about the index itself because typically there are sell-offs when they get to these kinds of levels. And that will undoubtedly impact my stocks as well. They won't be immune to something like that. But I can see an expected return for my stocks that is pretty good, higher than usual.

27:23And I think that they should do pretty well. Value will probably have a similar performance to the one that it had in the early 2000s through to the mid-2000s where it was doing pretty well while the index was flat. So you mentioned that the overall market could very well be flat over the next decade. Like you mentioned, part of that is human psychology. When things are good and stocks quote unquote only go up, people will pay whatever price necessary to get in on the action. And when there's blood on the streets, people will do whatever they can to get rid of their shares, no matter the price.

27:57And that value has higher than expected returns than what we typically see. If you had to put a number on that, what is your expected return? I don't want to step into any compliance issues by giving numbers, but I think that you could... What I like to do, it's a really simple thing to do. You could go to Morningstar, you could pull up my funds, and you could do that calculation. So people always say, there's not much information in multiples. So price earnings, price to book, dividend yield. Well, what does the underlying business look like? How good is the underlying business? I always find that really funny because if you have the price to book ratio of a portfolio and the price to earnings ratio of a portfolio, if you can take out the price, so you can invert both of those, eliminate the price, now you've got earnings on book and that's return on equity.

28:50If we have the dividend yield, we know how much money is being paid out from the earnings, and we know now how much is being reinvested. So we have the reinvestment rate by the return on equity. And so we can see what we have. Now we have the yield and the incremental returns, and that's an expected return. So I know that that's a little bit complicated. There's a great book. If you want to learn about this stuff as a younger investor, The best book, I think, is the one written by Bruce Greenwald. He's now retired, but he was the Graham and Dodd Chair of Value Investing at Columbia, which is basically where...

29:26That's where Graham taught. It's the best value school in the country or regarded as the best value school in the country. And his book is the best book, just outlining how you think through a valuation. And he says, you can calculate the liquidation value of a company, then you can calculate this thing that he calls the earnings power value, which is what the earnings are like without any growth. And then you can calculate a growth value for the company, which is similar to that explanation that I just gave, where you have a dividend yield and a reinvestment rate by return on equity. And that will tell you what these things are worth.

29:56And then you can reverse engineer that and apply that to just about any scenario. So it's a really, really simple tool for assessing these things. Once you've programmed it once into Excel, you can just drop the numbers in and it will give you an expected return number. And then you can spend the rest of your time thinking about whether the company will actually do these numbers in the future, which is where you should be spending most of your time. The quantitative stuff takes care of itself pretty quickly. The more difficult assessment is, so that kind of valuation wouldn't be appropriate for a cyclical, like a commodity type business, but it might be more appropriate for a business that has some pricing power, that has some visibility into where its earnings are likely to be in the future.

30:36And I think you can use it for portfolios too, because portfolios have a mix of different businesses and it eliminates the randomness from that kind of business. And so that book is an excellent book. It's like Value Investing from Graham to Buffett and Beyond. It's in its second edition by Bruce Greenwald. I think that most people regard that as one of the best introductory books to value. And that will give you that little tool that I discussed. So I think that you can, I can see, so there are very growthy companies, very growthy portfolios out there. And I could take that little assessment and I can drop that in and I can see what the expected return for those growthy companies are.

31:13And this assumes no mean reversion, just assumes no change in the multiple. That's the most important thing. And so then you can see, or you can get two portfolios that have the same expected return, but one trades at a huge premium to the market and one trades at a huge discount to the market. And it's possible that as an investor, you don't get the expected return in the one that trades at the premium because mean reversion does still exist over time. Those multiples will come into the market multiple or close to it in both directions. So that's probably what distinguishes me from a lot of other value investors in this market that I do still pay attention to that stuff.

31:43And I can look at two portfolios that have the same expected return and I just prefer the one that has the lower multiple to the one that has the higher multiple. Makes sense. And it's a very interesting approach. Now let's talk about inflation. It's a very hot topic in 2021. Got a lot of people talking about it. The CPI numbers released this month were 6.2 % for October, I believe, which many suspect is understated to a large degree. What do you make of the inflation numbers released? If you want to look really foolish in the future, what you should do is try to predict where inflation's going.

32:24So I hope someone's listening to this in 2025 or something like that and says, wow, you got that wrong. From my perspective, what has happened is we've had that flash crash in 2020 that rebounded very quickly. The Fed responded very aggressively and printed a lot of money, which it had been doing beforehand. And you can look at the growth in the Fed balance sheet has been absolutely extraordinary and become, it's asymptotically approaching infinite, it, I think, at this point, but it's a very big increase. And at the same time, we've had this supply disruption where goods aren't getting to the States because they're all on container ships that are floating out off the coast here.

33:02I can see them every day when I go for a drive around. You can walk to Catalina Island from Los Angeles. There are so many boats out there, and it's affected the air quality here. That's how many container ships are floating around out there. But the result of that, a whole lot of money dumped into the system and a restriction in the goods has created this scenario where we've got this massive increase in the cost of goods, the CPI. And there are two arguments, essentially. One is that this is transitory. The supply shortages will resolve themselves over time. And we'll go back to that sort of low inflation.

33:40I'm using the scare quotes constantly. I never use them. I don't know why I've got them out repeatedly for this, but I'm saying low inflation is that I don't think it's necessarily low inflation. I think the CPI sort of understates the true rate of inflation because there are lots of government programs attached to CPI that if CPI goes up too fast, they have to spend increasing amounts of money, pensions and so on. So the other argument that says that it's not transitory is that basically we have to keep on printing money at these very high rates or there's the lack of liquidity may cause the stock market to stall out and to crash.

34:15So we need to keep on jamming the money in. And then on the other side, that supply, that restriction and supply of all these goods sitting on the ships out here, that is a scenario that won't be resolved on optimistic assumptions until the end of 2023. When I hear someone saying end of 2023, just knowing how good humans are at assessing the likelihood of things happening, that may be the really optimistic outcome. And it may be that we don't know when that's going to be resolved. And as of today, it's the worst that it's ever been, which means it's got progressively worse. And you can pull up these scary looking charts about stuff sitting out there and how long it's been there.

34:54And it just keeps on going up every single day. And there's just no way to resolve that situation. There's a finite number of port facilities. There's a finite number of container ships. There are empty containers. It's a broken supply chain at the moment. We've seen this sort of stuff before in the 70s where you have the cost of consumer goods going up very quickly, wages not keeping up. It looks like wages may be going up now a little bit, although in real terms, they've gone backwards over the last 12 months, despite the fact that everybody thinks they're going up in real terms. They have gone up in nominal terms.

35:28My gut feeling is that this inflation is here to stay for longer. And when these scenarios play out, it's better for value guys. As sad as it is for everybody else, it is a good thing for value because value just tends to do better in higher inflationary periods. So put interest rates up at some stage, you sort of have to, that will probably precipitate some sort of crash in the stock market. And then it'll be a tough period to invest through. It'll be a tough period to live through, but it'll be good for value guys. I guess that's the silver lining for a handful of people like me. I don't think it'll be good for Americans when it happens.

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39:23That's theinvestorspodcast.com slash tip-finance. All right, back to the show. So does a higher rate of inflation that we're seeing today, does that affect your investing process at all or your thought process? No, because it's too hard to predict. Either way, low inflation or high inflation, I would still be trying to buy. I'm still trying to buy cash flows that go out into the future. I'm trying to buy them as cheaply as I possibly can because business is tough and there's lots of competition out there. I expect that my businesses decline slightly, but the fact that I've bought them so cheaply, it doesn't matter.

40:08Things like the level of the stock market and inflation is so hard to predict, so hard to know where they're going to go. You just can't factor that into a process. And I know that there are people who will say, well, go buy gold, go buy crypto. That's one way of protecting. But you can look at what gold's done for the last 12 months, pretty good period for inflation, supposedly, it didn't show up. Maybe it went through crypto. Maybe people have got a preference for crypto over gold. Then maybe that creates a scenario where gold's going to run really hard and crypto is not because it's expensive.

40:36But I don't have the tools to assess those things. And I don't think that anybody else does either. So I think that you just have to be humble and careful through this period. And even being humble and careful, I fully expect to get whacked pretty hard as this happens. Yeah, it makes sense. It reminds me when COVID first hit in March, April 2020, stocks were just going down, down, down, it was hitting the limit every single day. And I wasn't hearing too many people say, go out and buy stocks because no one knew what the virus was going to do, the effects it would have on the economy. And I think that's kind of what we're seeing with the inflation and supply chain stuff.

41:19I don't think anyone really knows the potential impacts over the next, at least a few years out. At least a few years. Yeah. I think that stuff did get pretty cheap. And I think I was recording podcasts at the time. We're doing them live. We're doing them in real time. I think our first live one was whatever Tuesday was closest to the March 2020 bottom. But I would say that for people who went through that and think that that is what a bear market looks like, you should go back and have a look at 2007 to 2009 and just hear how long that is, 2000, 2001. And then there are others, there are other 73, 74, those sort of bear markets different to the flash crash that we saw.

42:02And the difference is that in a bear market, every rally gets sold to a lower low and it happens over and over and over again for a very long period of time. And you get to this point where you think there's no way in the world, like the 15th rally that gets sold 18 months after the peak, you're punch drunk and you don't think it'll ever recover. That's often the point that it does recover, but there's nobody left to see it happen. You've got to get your mind right for when these things happen. You're going to feel like an idiot, increasingly stupid as this thing goes on. And the only thing you can do is concentrate on your plan that you have beforehand.

42:43If you're still earning an income, it's actually great, because it means that you're investing and buying more and more of the things that you want to own. And you should just keep on doing that. And at some point, it does recover, and then you'll feel great a few years later. It doesn't feel good when you're going through it though. So I was curious, in your valuation process, you're looking at liquidation values and other types of values and calculations you're doing. And today we have very low interest rates and very high inflation. So I was curious, are you using a discount rate in your analysis?

43:17And if so, how are you coming up with that? That's actually a great question. And I've spent a lot of time... It's one of the things that is, if you're doing a DCF, you need a discount rate. For discounted cash flow, it literally has it in the name, you need the discount rate. It's really, really hard. And this has been the hardest thing over the last decade is what's the right discount rate? And I don't know. And I don't think anybody else does either. I think that you could say, so, well, here's how Buffett does it. Buffett just doesn't pay more than 10 times. That's kind of his approach. And I respect it.

43:47It just means that he just doesn't ever pay up for stuff. He just waits until it gets cheap enough. Buffett's metric is 10 times what? 10 times earnings, 10 times his calculation of owner earnings. Good catch. I was going to let that one go. Yeah, 10 times owner earnings, which is... That's not the bottom line. That's what he thinks it's going to generate probably in cash terms for the business. So Apple sat there for a very long period of time when Apple got cheap enough, he put a third of his book into it and then it rallied three times. I still think that's the greatest trade ever because it's the most amount of money deployed in a single trade and then recovered so quickly.

44:24And he's so disciplined. He just sits in there. He's got$140 billion in cash, still sitting there waiting for something like that. He uses 10 times. I invest in a way that doesn't actually require a discount rate because that little explanation that I gave before, the one that is based on Greenwald's investment process or investment sort of tool, There's no discount rate in that. And I like that because it takes away that necessity of like, is 1.5 % the appropriate discount rate? Because that's the 10-year right now. Or would you want to take the long-run average of the 10-year, which is about 6 %?

44:58And that's historically what people have done, taken about 6 % and added some risk premium on top of that. I think that's what Buffett's doing. 6 % plus a risk premium probably gets him to about 10%. He hasn't seemed to have stepped it down much at all through this period. But I do it without using a discount rate. So there's no discount rate in that. Look at what the thing is earning. Look at what it's going to reinvest in its business. Look at what that will do incrementally. And one of the nice things about that is it does have built into it the multiple. It's just hard to... If you don't get enough of a yield back out, you don't get enough reinvestment back in.

45:35And so you're forced into these lower things. And you might then say, well, I know roughly what the market is expecting. So the market return on equity is about 13.3 % for the S &P 500. Reinvestment rate, I think, is about 60%. And so you can look at that and say, is this thing that I'm currently looking at a better company than average? Is it cheaper than average? I'm in a pretty good position here, I think, to do well. I tend to drive. I want much, much cheaper than average and about the average in terms of business quality. So I tend to pay a little bit less than 10 times, but I'm no Buffett.

46:13So if I was a better analyst, I might pay more. Now let's talk a bit more about your funds. The first fund I believe you started was the Acquirer's Fund. Could you tell us a little bit more about that one? Yeah, it launched in May 2019. At the time, the spread between the most overvalued and the most undervalued was extraordinarily wide, historically wide. It's proceeded to get wider since then, which that's not good for value guys. The idea is that it's just trying to buy the cheapest 30 names in the market. And I look at balance sheet and business quality, and I try to buy things that they're cheaper than they appear optically, and they're probably better than they appear optically.

46:55And I'm trying to buy them at a price that allows me to generate pretty good. So I want 15 % or better returns from each name in the book. And typically, I try to aim for about 17.5 % just because I think that there's a lot that can go wrong in business. A lot of these names aren't going to generate those returns. So I'm not saying these are the returns that the fund is going to do. I'm telling you what the raw input is at the top. And then whatever happens to these businesses happens to them. And I think that you probably likely see returns that are lower than that because competition and whatever else happens.

47:29And then I want businesses that... So they have to be rock solid from a balance sheet perspective, good businesses that are sustainable with pretty good margins. I'm mostly interested in margins. I'm less interested in return on equity because I think it's a mean reverting series for the most part, both ways. And I want management to be doing something about that undervaluation. So I want them in. They're buying back material amounts of stock. So you'll find there's lots of companies out there that buy back enough stock to sort of mop up the options that they issue to management every year. So it might even be like a 15 % buyback.

48:01It looks really good, but on a net buyback basis, net shares repurchased, it's flat or it's even the share counts going up. I want something that for a decade, they've opportunistically bought back stock at really good times. And that's often... So Lockheed Martin is one that's in my book right now. and I picked it up before Michael Burry did, or I picked it up at the same time that he did. I didn't buy it because he bought it. If you look at the share count, they've bought back about 17 % of their business over the last decade. It still generates really good returns on equity. It's a very strong balance sheet, very high transmission of earnings into cashflow, and it's a very, very stable business.

48:38And I think that that's one of those businesses that can generate mid-teens returns for an extended period of time, and you're not paying very much for it right now. So that's kind of pretty good representation of what ends up in the portfolio, just cheap, rock solid business, rock solid balance sheet, and what happens happens after I buy it. So does the fund go short some companies as well? How does that work? So the fund has shorted in the past. There are going to be some regulatory changes here that make it much more difficult to be short. And I also think that I've kind of reassessed myself as an investor having gone through March 2020.

49:16And what I think that I want to do, what we're doing now is we're going to remove the short book for the reason that it introduces, while having a short book means that I would inevitably do better in a drawdown, it sort of protects you on a mark-to-market basis. It does introduce this existential risk that any one of those positions could blow up. Now, I short very small. I short 1 % of the book or less, and I rebalance very regularly. And I tend to be in stuff that's not heavily shorted. So I already do all of those things. But nevertheless, you still run the risk when you have a short on that you get caught in.

49:52Tesla could go up many, many, not that I'm short Tesla, but you could be short Tesla and have it go up as many times as it has. But that's happened before with VW. I just forget the... I can't remember if it was poor. I just forget who it was, but they got squeezed and it can go up 10 times. So we've seen it with AMC, we've seen it with GME, we've seen it regularly. It's not a new phenomenon that short squeezes occur. But can I imagine if I stay short a book of names for the next 40 years that I will get short squeezed in this sometimes? It seems almost inevitable to me. So I think that what I would like to do instead is to remove the short book and just remove that risk completely.

50:32And I just rely on the fact that I can identify these undervalued names and over a long enough period of time, the market should wake up to the fact that they are in fact undervalued and they should be able to generate returns without the short book. So that's what I've done. We're in the process of taking off the shorts. We've already announced it to the market. It'll happen December 7th. And then from there on, it'll be a long only fund. Just for that reason that I'm trying to eliminate any little bit of risk that I can find in anything that could blow me up. Yeah, that makes sense. So your other fund is the Acquirer's Deep Value Fund.

51:06Is that right? That's the Small and Micro Fund. I partnered with Roundhill to do that. It's exactly the same approach. It's long only, but it's small and micro. They're all US focused only, so there's no international stocks other than there might be some Canadian or there might be some stuff that's got a secondary listing in the States that I will buy. It just has to be traded in the States. I love Small and Micro because that's where I started. The opportunity in Small and Micro continues to be one of the best that I've ever seen. It's just been so beaten up for so long. What the market has been for the last decade has been high growth, large cap have really been the beneficiaries.

51:42And so if you look at, again, if you go to Morningstar and you have a look at the style boxes of the funds that have done very well, like ARK, for example, their little, you know, their centroid will be high growth, large cap, and their distribution is all like heavily slanted up into that right-hand corner. And if you look at the funds that I run, they tend to be on the exact opposite side. They'll be smaller and they're extreme value. So when any sort of external party does a third party factor analysis of my funds, the first thing that stands out is they are the deepest value funds that you'll find out there.

52:15And the second thing that stands out is they tend to be very high quality because I like cash flows and stock being brought back. That hasn't done very well in this market until about February this year. It has started to do a little bit better relative But the ordinary course is that that approach to the market, smaller and better, and value has typically been a good way to generate better returns than the market. So I think that over time, given enough time, that's sort of what we'll see. Tobias, thank you so much for coming onto our show and sharing your knowledge. I think just with the current environment, it's so important for people to learn about and at least hear about value investing again, consider how it might fit into their own portfolios.

52:59Now, before I close things out, where can the audience go to connect with you and learn more about you and your funds? Hey, thanks so much for having me on, Clay. I really enjoyed that conversation. There's some great questions in there. My firm is called Acquirers Funds, and it's acquirersfunds.com. I have a little website called acquirersmultiple.com, which has got a free stock screener. And we post podcasts and blog posts, just walking through value investing and deep value investing and people who are in the space and what's happening, what people have said. And I do this with two buddies of mine who are both value investors.

53:37We have a little podcast where we chat about it called The Acquirer's Podcast. I'm on Twitter at Greenbacked, G-R-E-E-N-B-A-C-K-D. It's a funny spelling. I'll probably have to change that at some point. But I post the links to all the stuff that we do on that, if that's your preferred approach. And the two funds are the acquirer's fund, which is the mid cap and larger. That's Z-I-G, ZIG, because you want to ZIG when the market zags. And then the small and micro one is deep because that's deep values, the approach. But they're the same approach to the market. Just one is mid cap and large cap, and the other one is small and micro.

54:09Got it. I will say that I do enjoy listening to you, Jake and Bill talk about the markets on your show. I appreciate that. We tried to recreate, it's called Value After Hours. We tried to recreate these conversations that we were having. I mean, we were having these conversations on Zoom and I just thought this would be fun if we could keep on doing this and people hear what we say, because this is what you guys talk about behind closed doors or in the bar after hours. And we're pretty open and you've seen we're open about what we think about Tesla or crypto or NFTs, for example, And so I get lots of nice emails.

54:45I get lots of nasty emails, but it's all authentic. It's the real thing. I love it. Toby, thank you so much for coming on. Thanks, Clay. My absolute pleasure. All right, everybody. I hope you enjoyed today's episode. Please go ahead and follow us on your favorite podcast app so you can get these episodes delivered automatically. And if you haven't already done so, be sure to check out our website, theinvestorspodcast.com. There you'll find all of our episodes, some educational resources we have, as well as some tools you can use as an investor. And with that, we'll see you again next time. Thank you for listening to TIP.

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