You have maybe heard about the Acquirer’s Multiple. It’s a quantitative value strategy based on the multiple EV/operating income. The man behind this strategy is Tobias Carlisle and he also wrote a great book called Deep Value. The strategy is very simple. It’s basically buy stocks with the lowest EV/operating income ratio and rebalance your portfolio once per year. According to his book when doing a backtest using this strategy, the returns have been very impressive. From memory I think it was around 18% annualized. This strategy has worked very well when backtested trough the past decades. EV/Operating income is also considered the cleanest valuation multiple as it include the debt of the company and also its difficult for the management to manipulate operating income.
But will it work in the future?
There is no guaranty of that, and with today screeners and computing power it’s easy to get a list of the lowest EV/Operating income stocks in the whole universe of stocks. That was probably not easy to do in the years up to the year 2k.
Why does the Acquirer’s Multiple work?
I think the reason is of psychology and human nature. The stocks that typically shows up on the screener is usually unpopular, hated and companies where the future is uncertain. This is the reason for the sell off by investors and the low price. And this create a higher chance of mispricing when the emotion regarding a stocks is more towards the extreme. So buying a diversified portfolio of low EV/Operating income stocks will make you be able to take advantage of this mispricing. The key is to be diversified because some of these stocks really deserve the low price. Typically 20-30 stocks is recommended. Another reason is reversion to the mean. Most things are cyclical companies that has financially underperformed for a period tend to have a period of better performance.
A deeper look at the numbers behind the Acquirer’s Multiple
I was curious what numbers characterize the stock except the low EV/Operating income ratio. In the Deep value book the author explained that adding quality components like a high ROE actually decrease the returns instead of adding to the return. So I took all the 30 or something stocks and put it in a stock screener that give me all of the most important fundamentals ratios. I used a free trial of Uncle stock stock screener.
Here is what I found:
Acquirers’s multiple- Excel Spreadsheet
Here are the median numbers for the 31 stocks:
P/E: 9.39
EV/Operating income: 7.3
Dividend Yield: 1.7%
F-Score: 6.38
Z-Score: 3.26
M-Score: -2.44
Current ratio: 1.40
CF Coverage ratio: 65.2%
LT/Debt to equity: 52.9%
FCF/LT-Debt: 21.7%
Quick ratio: 0.87
ROIC 5t avg: 15.5%
ROIC: 16.7%
FCF/Total assets: 5y avg: 4.9%
FCF/Total assets: 6%
CROIC 5y avg: 7.6%
CROIC: 8.0%
ROE 5y avg: 17.3%
ROE: 20.2%
ROA 5y avg: 6.4%
ROA: 8.2%
FCF/sales 5y avg: 3.1%
FCF/sales: 3.5%
Gross margin CAGR: 1.9 %
Held by insiders: 0.5%
Held by institutions: 87.3%
Outstanding share 1 year growth (share buyback): -4.6%
Outstanding shares CAGR: -2.4%
Price YTD change: -13%
Gross margin 5y avg: 22.7%
EBIT margin 5y avg: 7.5%
Net margin 5y avg: 4.8%
Shareholders yield: 7.1%
Damn what a long list.
This is my take on these some of these numbers:
- Ev/operating income ratio is low but not extremely low.
- The F, Z, and M-score is all within the limits of what can be considered acceptable. This is an indication for me that there is indeed some addition screening is being done than just spitting out a list of low EV/OI stocks.
- Low D/E around 0.5 which indicate good financial strength
- surprisingly high ROIC and ROE. Above 15%. So this shows that these companies have not been crappy companies in the past.
- The Gross, EBIT, and net margin are quite low.
- Shareholder Yield very high at 7.1%. This shows that the management are returning back money to the shareholders in form of dividends or share buyback. This also can indicate that the management themself think that their own stock are selling too cheap compared to their intrinsic value
Conclusion:
Looking deeper into the numbers we can see that the quality of the stocks that is selected is not as of bad quality as I first imagined. On average they also seem to pass the financial forensic screening of F,Z and M-score. Historically the ROIC and ROE has been quite good. Seems like there is more to it than just a low EV/OI ratio. Also in contrast to what I remember reading in the Deep value book these stocks the high ROIC would decrease the annual return, but still it seems like the stocks also have been screened for a high ROIC.