We Study Billionaires - The Investor’s Podcast Network - TIP 025 : Deep Value Investing - w/ Tobias Carlisle (Investing Podcast)

Starting point is 00:00:00 This is episode 25 of The Investors Podcast. Broadcasting from Bel Air, Maryland. This is the Investors Podcast. They'll read the books and summarize the lessons. They'll test the waters and tell you when it's cold. They'll give you actionable investing strategies. Your host, Preston Pish, and Sting Broderson. All right, how's everybody doing today?

Starting point is 00:00:29 This is Preston Pish, and I'm your host for The Investors Podcast. And as usual, I'm accompanied by my... co-host Stig Broderson out in Denmark. And I'll tell you what, folks, we are pumped today. I'm excited for multiple reasons. First of all, we've got a guest on the show that I'm very excited about because this guy is probably one of the most intelligent people we've run across in a long time. We have Toby Carlow on our show, and Toby is going to be talking to us about Deep Value, which was a book that he wrote. This book was published by Wiley Finance. He also, wrote another book called Quantitative Value. And Toby has a really unique background because

Starting point is 00:01:09 he's not only an expert in asset valuation. He's a former corporate advisory lawyer, which is pretty impressive in itself. He worked on corporate mergers and acquisitions in a multitude of countries like China, Australia, Singapore, and many others. And his book that he wrote, I'm serious. This book, I haven't had a book that has impressed me as much as Toby's book since I read security analysis. And I know some people might, you know, say, Preston, you say that about every book that you read. And I do. I'm usually pretty energetic about each book that I read.

Starting point is 00:01:39 But this one was very impressive because it flies in the face of a lot of ideas and theories that people have about value investing. And he not only says these things, but he backs it up with fact after fact after fact. And he has all this quantitative data to back up his opinions and his theories and his, his theories in his book. And so Toby, with that entry into the start of the show, I just want to say thank you so much for taking time out of your day to talk to Stig and I about your book and just helping our audience understand value investing at a much more profound level. Wow. Thanks very much for that very kind introduction, Preston. It's a pleasure to be on with you us. So the first question I have, Toby, in a few sentences, I want you to describe what your book

Starting point is 00:02:28 Deep Value is all about. Second, and the follow up to that is I'm curious to know what your motivation was for writing the book. It seems like you wanted to provide hard facts to support some of your theories, but was there something more to it than that and the reasoning behind your writing? Deep Value is about the method that contrarians, uh, act. activist investors, private equity firms, professional investors used to value companies in their entirety when they're looking to take them over or get on a board and sort of control the destiny of the company. In the process of doing that, I sort of examine this idea of mean reversion, which is the force

Starting point is 00:03:18 that pushes intrinsic value or price back to me. intrinsic value, which is one means by which value investors make their return. And the other is this idea of mean reversion in fundamental business performance. So you can see most industries, most businesses, most stock markets are cyclical. And they'll have these periods where they have very good returns and they have these periods where they have very poor returns. And if you're looking at the trend in earnings, you can sometimes be fooled by that mean reversion. And so the point of the book was just to say that in most instances, for most businesses, there is going to be this fundamental mean reversion. And if you can sort of anticipate the implications of that and you can

Starting point is 00:04:11 get something that's cheap kind of at the bottom of its business cycle, then you get both the difference between the market price and the intrinsic value, and you sort of catch the intrinsic value wave up and you get very good returns as a result. So it was funny because in the book, whenever you started talking about this mean reversion, Toby, what he does is he goes, I want to see the worst performing companies in the last three years, and then I want to see the best performing companies in the last three years based on their earnings and how much their earnings were growing or descending. And he takes the worst companies, and I think you took the 30 worst companies and then you took the 30 best companies.

Starting point is 00:04:51 And then he said, okay, I'm going to create a portfolio. I'm going to buy the 30 worst and the 30 best. And let's track how these companies perform over the next three years into the future. And what he found whenever he tracked the 30 best and the 30 worst is that the 30 worst outperform the 30 best by just a huge margin. You're talking at least over, what was it, over 10 percent. I can't remember the numbers off the top of my head, Toby. There's several analyses there that come from some research in the 80s by DeBonte and Thaler. And the idea is that if you look at the earnings per share trend over the preceding three years

Starting point is 00:05:34 and then you buy on T0, so you buy after the three years and then you hold for another three years, the earnings per share of the companies that have had the greatest declines actually end up having the best performance. And the reverse is true for the earnings per share. So it's a fundamental analysis. So you buy these companies that have falling earnings and then they have very good performance. So Toby, what you're basically saying is that we don't really pick the companies

Starting point is 00:06:05 that we think we'll perform best. We're basically looking at through a stock screen or through simply through a formula. and we know that these were simply performed better than the stock market in general. So that analysis that De Bonn-Failer did was just to show that there is some fundamental improvement on average when you're looking at those three. There are a variety of value metrics that you can use that have phenomenally good performance, remarkably good performance for how simple they are. And really, you can use almost anything.

Starting point is 00:06:40 the humble price to earnings formula works very well, price to cash flow, price to any fundamental will perform very well. In quantitative value, we rigorously tested all of the formulas to sort of determine which one worked the best. And we found that it was the enterprise multiple. And we tested it using earnings before taxis and earnings before interest taxes, depreciation, amortization. So that's EBIT and EBITDA. And the denominator there is enterprise value, which very simply is market capitalization plus the debt that you have to take on because that's what acquires of companies in, they take on the liabilities of the company. And then you net out of that cash, but you have to add in anything like minority interests. So you're really looking at

Starting point is 00:07:32 the full price that you pay. And then you're comparing that to the operating earnings that you're getting on the other side. And we found that those two outperform when we apply some fairly rigorous analysis to it, so we look in a very large universe and we market capitalization weight them. So it's not a phenomenon of just being very small companies outperforming. It's actually the very big ones. It does select big companies that outperform. So when I actually go to apply that formula, The best way to do it I have found is using this number that I call it the acquires multiple. Basically, it's substituting operating earnings, which is a metric that you construct from the top of the income statement down. So you take revenues, you take out cost of goods sold, and then you take out selling SG&A.

Starting point is 00:08:25 And the reason that you get a better result when you take it from the top rather than the bottom is that you're missing out on any of the special items that aren't necessarily part of the operating business. And then if you use that metric, you're really selecting for the kind of companies that a large acquirer can take over. And so they tend to be, they tend to perform quite well. And they also fit into attract catalysts in the form of activists and private equity firms. You know, Toby, the thing that kept popping up into my head as I was reading your book was a lot of people are just so focused on Warren Buffett and the way that he does business.

Starting point is 00:09:02 And the one person that we're really focusing on a lot these days and paying very close attention to is Ray Dalio. I know I sent you an email just the other day when we were talking about something kind of off topic to what we're discussing right now. But Ray Dalio, from what I understand, is implementing a process that is very similar to what you're talking about here as far as using nothing more than quantitative data to make decisions in the stock market. and he's not really doing anything like Warren Buffett where he takes a lot of this qualitative feel. And when you look at Ray Dalio's returns based on where he's at in his lifespan, his returns are actually more impressive than Warren Buffett's for where he's at right now as far as having larger returns. And to me, I was reading your book and I'm thinking to myself, you know, I really think that Ray Dalio is taking a very similar approach to what you're talking about here in the way that you're analyzing stocks. Would you agree with that? And I know this is one of the questions that we were planning on going over, but I'm very

Starting point is 00:10:02 curious to know your response to that. Dahlio is one of a number of guys who are quantitative in their approach. I think probably the most famous is O'Shaughnessy asset management, or it could be any of the firms that sort of came out of the academic research. So, LSV asset management is Lachon Shlifern-Vich-Schlafe and Vishni, who wrote one of the great papers Contrarian Investing, which he, everybody should read. And I do cover that in the book. De Bonne Thaler have a firm. And the reason I like Ashornnessy is he's been very generous sharing exactly the process that he goes through in his

Starting point is 00:10:39 book What Works on Wall Street. And the idea is basically without sort of knowing precisely what Dahlia is doing. And I know that he's sort of a, in addition to stocks, he looks at various different asset classes. And so there's a asset allocation function to what he does, which is part of his return profile, whereas Buffett's known more as a sort of a stock market investor, and so is O'Shaunacy for that matter. So I'll just speak to O'Shaunacy because it is the same point. Ashornancy has sort of looked at all of these different fundamental metrics for analyzing the stocks, and he's also looked at some momentum metrics.

Starting point is 00:11:20 Momentum is a very powerful force. I don't use it in my firm, but there is quite a lot of academic research that shows that it does work. Momentum is basically price performance over a period of time. So the most popular is 26 weeks, which is half a year, which you can also use 52 weeks. And it seems to be slightly uncorrelated to value. So you get combined together. They get very good returns.

Starting point is 00:11:42 So I assume that Dalia is using some combination of value and momentum to generate his returns. All right. Well, let's go to – we do have the next question here. Let's go to this one. So Toby, Warren Buffett has a really famous quote, and the quote goes like this. It says, when a management with a reputation for brilliance tackles a business with a reputation for bad economics, it's the reputation of the business that remains intact. And so I guess my question is this, because you provide hard facts in your book that shows

Starting point is 00:12:10 that the really ugly businesses when you measure a return on invested capital, the ones that have had a really bad past performance are the ones that are actually maturing and turning into a much better investment over a short number of years right after you would have selected it. So can you describe this to our audience, this idea and how you came across this contrarian point of view? Let me first say that I don't necessarily disagree with Buffett's quote there. I do think that the management is sort of tied to the underlying performance of the business. And this is one of the big differences between Buffett and Graham. So Benjamin Graham was Benjamin Graham wrote security analysis and he was Buffett's teacher.

Starting point is 00:12:54 one-time employer, lifelong friend. And Buffett says that he's sort of 75% Graham. The other 25% is Phil Fisher. But he obviously, he called one of his sons, Graham. So he's got a huge regard for Benjamin Graham. One of the points that Graham makes in security analysis is that when you look at a business, it's very difficult to separate out whether it's in fact a very good management or whether it's just a business that's enjoying a particularly good period.

Starting point is 00:13:26 And he says that if you're looking at that and saying that's a great management, what you're missing is the fact that you're potentially double counting. That's the way he describes it. And Buffett's big departure is that he has come along and said, well, there are these managements that are worth paying up for because of the way that they behave. And the two things that you want from management is this sort of relentless focus on the moat and maintaining that very high return and invested capital by doing so. And so you keep the return very high,

Starting point is 00:13:59 but you also have to look after the capital that's invested in the business. So you don't allow too much cash to build up on the balance sheet. You're very careful with the acquisitions that you make. You pay out a dividend when it's warranted. You buy back stock when it's cheap. And to the extent that they don't do those things, they're sort of destroying the intrinsic value of the business. So that's one of the points that I make in the board.

Starting point is 00:14:20 that often activists and private equity firms, the simplest way that you can improve the intrinsic value of a company is when you come in and you find that they're not performing that capital allocation function properly. So there might be two elements. There might be the sort of operator function of the management, which is running the business. And then there's the capital allocation function. And to the extent that they're not doing that, that's an obvious place where activists and private equity firms add value. And that's where you see, and you even mentioned this in your book, where a guy like Carl Icon comes in and just unlocks that value that's just stored on that balance sheet. And he comes in, he can see it there.

Starting point is 00:14:58 And he just basically hits the management over the head and makes them unlock it. And it's a pretty amazing story that you had in the book about Carl Icon because a lot of that stuff I'd never read before is really good. Go ahead, Stig. So, Toby, I came to think of a thing here because how does tax play a role? If you pick stocks like Warren Buffett, you have this compounding effect, which is clearly very powerful. And this is one of the key things about finding wonderful businesses. And even in bad times, you know, they don't have to pay the capital gains. I might be wrong, but using, let's call it your approach, I guess that you will wait until those stocks will return to the intrinsic value.

Starting point is 00:15:41 And then you have to liquidate them and to incur the capital gains tax. So what are your thoughts on that? I don't think that one is any better than the other. I just think that part of the reason that I wrote the book is that Buffett is so successful and he's been so generous with his writings over 50 years and he's spoken publicly at every Berkshire General meeting and he's interviewed all the time. So Buffett's method of value investment is the sort of way that everybody thinks about value investing. But really the targets of Buffett's targets.

Starting point is 00:16:13 of Buffett's targets are so few and far between. There are a very small portion of the market, those sort of companies that can sustain that high return and invested capital with the mode. Really, the vast majority of companies are cyclical and they are subject to the forces in their industry that are sort of exogenous external to their own businesses. So I don't necessarily think that one is better than the other.

Starting point is 00:16:37 I just think that you have such a larger universe to work with if you work with these companies that are a bit more cyclical or subject to those forces. So that is one of the problems with investing this way is that you are more likely to incur capital gains tax. But that's also true of many of the Buffett companies do, they don't really, you can't remain invested in them for, many of them for sort of 50 years. Often they're sort of a five or 10 year proposition and then they just run out of growth potential or the market becomes saturated. can be any sort of number of those issues. With the companies that I look at, I'm still thinking in terms of three to five year to 10 year period.

Starting point is 00:17:21 It's just that I'm trying to get them really out of business and idea, and then they work through those issues. And so they have a pretty long runway where they're getting back to the peak. So how do you determine the growth potential? And the reason why I'm asking is that, and please correct me if I'm wrong, but you're not looking so much of the quality of those companies and you're not so much look in terms of, say, your circle of competence,

Starting point is 00:17:47 you merely looking at numbers and what might be at the bottom of the business cycle. So how do you determine when to sell? Well, often these things, that decisions made for you by some sort of catalyst occurring, but when it reaches, either it reaches intrinsic value or you find a better opportunity that's at a bigger discount, that tends to be the way that the portfolios operate. The question I think, and the point that I make in the book,

Starting point is 00:18:21 I use Joel Greenblatt's magic formula as the means of describing this point. But Greenblatt has this magic formula where he looked at Buffett's letters and he said, how can we quantify this? And if we quantify it, you know, will we get good returns? because we don't have Buffett's genius for finding these moats, and there's no sort of real statistical way of finding these moats. Or certainly not looking at the financial statements. So he said, well, there are two things.

Starting point is 00:18:49 He looks for quality, which he defines as a return on invested capital, return on tangible capital, and we look at value, which he defines as earnings before interest and taxes on enterprise value, what I call the EBIT enterprise multiple. And then he just simply ranks every stock on each factor. and then he sums the ranking. So the best combination of both is a magic formula stock, and then he buys portfolio of 30 rebalances on an annual basis.

Starting point is 00:19:14 And that outperforms the market. We've independently tested that in quantitative value, and it's been tested a variety of other times outside of us, and it definitely outperforms. Let's take a quick break and hear from today's sponsors. All right, I want you guys to imagine spending three days in Oslo at the height of the summer. You've got long days of daylight, incredible food, floating saunas on the Oslo Fjord, and every conversation you have is with people who are actually shaping the future.

Starting point is 00:19:45 That's what the Oslo Freedom Forum is. From June 1st through the 3rd, 2026, the Oslo Freedom Forum is entering its 18th year bringing together activists, technologists, journalists, investors, and builders from all over the world, many of them operating on the front lines of history. This is where you hear firsthand stories from people using. Bitcoin to survive currency collapse, using AI to expose human rights abuses, and building technology under censorship and authoritarian pressures. These aren't abstract ideas. These are tools real people are using right now. You'll be in the room with about 2,000 extraordinary individuals, dissidents, founders, philanthropists, policymakers, the kind of people you don't just listen to but end up having dinner with. Over three days, you'll experience powerful mainstage

Starting point is 00:20:33 talks, hands-on workshops on freedom tech and financial sovereignty, immersive art installations, and conversations that continue long after the sessions end. And it's all happening in Oslo in June. If this sounds like your kind of room, well, you're in luck because you can attend in person. Standard and patron passes are available at Osloof Freedom Forum.com with patron passes offering deep access, private events, and small group time with the speakers. The Oslo Freedom Forum isn't just a conference, it's a place where ideas meet reality and where the future is being built by people living it. If you run a business, you've probably had the same thought lately.

Starting point is 00:21:12 How do we make AI useful in the real world? Because the upside is huge, but guessing your way into it is a risky move. With NetSuite by Oracle, you can put AI to work today. NetSuite is the number one AI cloud ERP, trusted by over 43,000 businesses. It pulls your financials, inventory, commerce, HR and CRM into one unified system. And that connected data is what makes your AI smarter. It can automate routine work, surface actionable insights, and help you cut costs while making fast AI-powered decisions with confidence. And now with the NetSuite AI connector, you can use the AI of

Starting point is 00:21:50 your choice to connect directly to your real business data. This isn't some add-on, it's AI built into the system that runs your business. And whether your company does millions or even hundreds of millions, NetSuite helps you stay ahead. If your revenues are at least in the seven figures, get their free business guide, domesticifying AI at netsuite.com slash study. The guide is free to you at net suite.com slash study. NetSuite.com slash study. When I started my own side business, it suddenly felt like I had to become 10 different people overnight wearing many different hats. Starting something from scratch can feel exciting, but also incredibly overwhelming and lonely. That's why having the right tools matters.

Starting point is 00:22:35 For millions of businesses, that tool is Shopify. Shopify is the commerce platform behind millions of businesses around the world and 10% of all e-commerce in the U.S. from brands just getting started to household names. It gives you everything you need in one place, from inventory to payments to analytics. So you're not juggling a bunch of different platforms. You can build a beautiful online store with hundreds of ready-to-use templates, and Shopify is packed with helpful AI tools that write product descriptions and even enhance her product photography. Plus, if you ever get stuck, they've got award-winning 24-7 customer support.

Starting point is 00:23:12 Start your business today with the industry's best business partner, Shopify, and start hearing Sign up for your $1 per month trial today at Shopify.com slash WSB. Go to Shopify.com slash WSB. That's Shopify.com slash WSB. All right. Back to the show. And Toby, the thing that I was really focusing in on was the time period that you had, the three years before, the T-0 mark, and then three years after.

Starting point is 00:23:48 Were you really seeing that you? you got the best results over that six-year window. Did you guys play around with expanding that to maybe an eight-year window or a four-year window? Like, what gave you the best return? Was it six years? Is that why you used that in the book? That's the DeBont and Thaler research, which we didn't test specifically for windows, but we did look at holding periods. So, sorry, we looked at, we looked at holding periods and an average of years. So in order to select the stock. So you look at the cheapest on one years of earnings, one year's earnings, two years of earnings, average of three years. And I think we went out to eight years.

Starting point is 00:24:26 Look, this is in quantitative value. And we found that there's really no advantage to expanding the number of years that we considered, which I found really surprising because that's one of the things that I was expecting that that would be a big advantage because there aren't many people who sort of go to that, when they're analyzing companies to the extent that they're thinking about, they're looking at only a few years of financial statements. So I thought that would be a big advantage. It turns out it's not.

Starting point is 00:24:52 And so it's something that it sort of perplexed me at the time, and I've thought about it a lot since. The reason is that when you look at the companies that it selects on a one-year basis, I should just say there were, you know, it might be that five years is a better average, then six years wasn't very good, and then seven years was quite good. So there was just, there may have been ones that outperformed an individual year, but there was no sort of rhyme or reason to it. So they were just sort of random. So how about on the backside?

Starting point is 00:25:20 After it's selected, you had in the book that three years later, and whenever I looked at that chart where it basically, they all come back into a normalized state, it was usually about a three-year period. Did you find that three years of holding usually brought it back or if it didn't, it was just kind of an outlier? Was that three-year period pretty common? Or did you try shortening that and seeing how that worked? You definitely continue to get, so holding for a year gets you the bulk of the return because that the gap between intrinsic value and price is widest at that point. And then it sort of gets closer and closer and the return disappears a little bit

Starting point is 00:26:02 because the discount is not so great. And this is one of the things that I tried to get across in deep value, the discount from intrinsic value really is the driver of returns. The bigger the discount, the better the returns. So as the discount diminishes, the return diminishes too. But you still get it, I think out to five years, I think out to seven years. I think you're still getting pretty good performance out as far as that. So the key would really be, what is my capital gains tax?

Starting point is 00:26:31 And let me get past the largest hurdle of that. Let's say the biggest capital gains would be a year. So you'd want to sell it and basically re-baseline everything. after that one year mark, because that's where you really move completely into a different capital gains bracket here in the U.S. at least. Is that what you're doing on your business individually? It tends to be one year and one day. That gives you the best combination of capital gains and tax diminution. All right. Stig, you got the next question. So, Toby, at your talk at Google in November 2014, and Just a quick shout-up for that talk.

Starting point is 00:27:11 We would definitely link to that in the show notes. That was a fantastic and really inspiring talk. You can't see this, guys, but Toby is almost blushing right now. Hey, and I want to throw in. Glenn Samia was the person who sent us the link to your talk at Google. And we just want to thank Glenn for giving us that handoff. But go ahead, Stick, sorry to interrupt. No worries.

Starting point is 00:27:32 So Toby, let me go to the question again. So at your talk at Google, you state that it acquires, multiple, which you talked about briefly before, is widely used to find the hidden value of businesses. You also find that it outperforms other key ratios such as free cash flow yield, gross profit yield, and book to market value. What is the acquires multiple if you have to define it real fast and why does it upperform the other metrics? The acquirers multiple is operating earnings on enterprise value, which is the full price that anybody pays for a business.

Starting point is 00:28:09 So the extent that you're valuing a company, you're always, the enterprise multiple is the price that you're paying. And operating earnings is the income stream that you're really getting, that you can then either direct to capital allocate, you can allocate it to dividends or buying back stock or investing in other businesses. So it's really telling you how much you're actually paying for the business and what you're getting in return.

Starting point is 00:28:33 It's probably the best, cleanest analysis. of that, which is why I think it performs so well, and it has been shown to do that empirically. Why it outperforms free cash flow, gross profit yield. I'm not entirely sure. I think that was a little bit surprising because if you come from the Buffett, a lot of the Buffett investors, what they're really looking for is that very high free cash flow yield. Well, not necessarily an extremely high one. They're looking for a sort of a solid free cash flow yield, maybe 10% plus with some growth,

Starting point is 00:29:07 maybe 5%, and so combined, you're getting about a 15% return. And then they want that sort of very stable over a very long period of time, whereas the deep value guys are kind of looking for a really fat return in the very short term. And the only way that you're going to get that is with these really ugly businesses. And Toby, I just want to highlight for people because when you're thinking about risk. The reason you have a lot of these Warren Buffett people, like myself, that's managing their risk based off of a very stable, predictable trend line of this free cash flow. You're managing your risk because you're buying 30 or call it 50 companies that are all in this very deep

Starting point is 00:29:53 category. And let's say five of those businesses fail. You make it up through the other businesses that have had these very large returns because they've performed so poorly and they've been penalized in the market. And that's how he's managing his risk. I just wanted to throw that out there so the audience understands that you are managing your risk, but you're doing it in a different manner. I do some of the Buffett investing as well. So, but I just, the Buffett stocks are really much rarer than the other ones. So, and for those ones, I'm always looking for that sort of, I want 10% free cash flow yield, you know, going out two or three years. So I can see it occurring. two or three years time with about a 5% growth rate, pretty stable returns, good capital allocation.

Starting point is 00:30:39 You know, that's a very, that's a traditional Buffett-style stock. For the other ones, I look at 20 positions and you're sort of getting, you need to get more for the risk that you're taking on there. So do you get more in terms of an enterprise multiple? And the multiples that I'm looking at are, you know, I want to buy it three times or at four times. So that's like a 25% to 33% yield. You know, that's a really fat yield. That thing is ugly. At any given time in the business cycle, whatever is the scariest thing is the sort of thing that you're buying.

Starting point is 00:31:12 So, you know, right now it would be oil and gas. Yeah. It's probably iron or minus. You know, there's no secret to this. It's, you know, multi-level marketing. You know, the sicker you feel when you look at the portfolio, the better the portfolio is going to go. All right, Toby. So many investors look at the PE ratio and use that to quickly determine the expected yield

Starting point is 00:31:33 of an investment. Continuing with our previous question, if you could quantify how much better the performance was when you were using the Acquires Multiple versus just the standard PE ratio. And then also talk about Joel Greenblot's magic formula, where that kind of fits into this. What would you say the performance might be for just like an index of stocks as far as the yields that you quoted in the book? When we looked at the very large capitalization universe, so we looked at a capitalization universe, So we looked at companies with a market capitalisation bigger than $1.4 billion as at December 31, 2011, because we wrote it in 2012.

Starting point is 00:32:14 And we market capitalization weight of the positions in the portfolio, which you wouldn't ordinarily do when you construct a portfolio. You either equal weight or you'd wait towards your best opportunities, so the most undervalued opportunities. So we did that because that penalizes big. bigger companies. And there are often little ratios that sort of work to find small stocks that aren't really particularly good at outperforming the market.

Starting point is 00:32:42 But we found it gave us about on average compound over a sort of 32 year period, about 15 or 16 percent per year. And the PE ratio, from recollection, I'm not entirely sure, but it was sort of around 11 or 12%. So it's a fairly substantial margin over 32 years. It's an enormous outperformance. All right, Stig, you got the next one. So Toby, how have the hot facts about pure quantitative models to find the best stocks change your own approach to your stock selection? So when you're investing, there are two, I like to think there are sort of two broad approaches to investment. One is the Buffett-style business.

Starting point is 00:33:30 owner investment method where you look at the business and you look at the qualitative factors in the business what's going to allow it to outperform to protect its returns on invested capital you look at management's attitude to capital allocation as evidenced by what they've done in the past and perhaps to the extent that you can talk to them what they tell you that they're going to do in the future the other approach is to sort of look at it like like the statistician or the casino owner, maybe. It's kind of like a probabilistic approach.

Starting point is 00:34:06 And so the quantitative approach is to the statistical probabilistic end. And in that approach, you look at a period of data beforehand. And then to protect yourself from sort of all of these little biases that can creep in, you have to approach it. I think you come up with an idea that you test. So does value work? It seems to. when we test that using any number of different ratios,

Starting point is 00:34:32 you find a good ratio. And then you have to apply that without fear or favor to the stocks that it selects. Because what you'll find is that it pulls up all of these things that they don't ever look like a really good idea. And what you'll find, if you go through and try to cherry-pick those ideas out, is that you tend to underperform the screen. And the reason is a fairly well-known region of,

Starting point is 00:34:59 research, little less well-known in investing circles, but quite well-known outside. It's this idea that experts tend to underperform these simple statistical models. And the reason is that they use their discretion to sort of override the model too often. And that's what is known in the research as the broken leg problem. So the idea is you have some sort of algorithm that tells you that Peter goes to the theatre on a Friday night. and you learn, you're trying to predict will he go this Friday night and you learn that he's got a broken leg. So surely you're able to factor that into your algorithmic model

Starting point is 00:35:39 to determine that he's not in fact going to go to the theatre. And the answer is no. And that's really surprising. And the reason that you can't use it is because you find way too many broken legs. You want to apply it more often than the model would. And so the model has this error rate, but it's a known error rate, whereas experts seem to have this sort of,

Starting point is 00:36:02 when they're making decisions on an ad hoc basis, they have this unknown fluctuating error rate. So what they've found in these lots of different unrelated fields is that the statistical model acts as the ceiling on performance and anything that you do to the screen sort of underperforms it. So when I'm in the quantitative mode, I just run what is in the model, and I put that in the portfolio.

Starting point is 00:36:27 So I loved in the book. So I'm going to just going to add on to what Toby said. But in the book, he shows that in Ben Graham's security analysis, he talks about this idea of using your own intellect, like using the screener to bring you to a batch of stocks and then to basically use your own intelligence and your own qualitative field to extract the ones that you think would be the right ones. And so then Toby talks about how Ben Graham basically changed. his mind very close to his own death. I think the year was like maybe 1975 or 76 that Graham came out openly and basically came back on what he had put in security analysis and said, you know, I don't really necessarily know that I agree with this anymore. I think you should just take the batch of stocks that come up from the screener and you just invest in those

Starting point is 00:37:16 from what you got and that you don't use your own biases to select the right ones because I think that's going to cause you to actually underperform. And so Toby puts that in the book and he talks about how ahead of his time Ben Graham was even right up to his death, to be able to identify something like that without having access to computers to basically validate that extra 2% gain that you actually get, that Toby is statistically proven in his book. So with all that said, I'm going to go to the next question. So if you could only pick one investor outside of Buffett, Munger, and Graham that people should study, who would that be? And do you have any books that maybe that person would have wrote or anything like that? I've got to give a shout out to Joel Greenblatt because I've learned so much from Greenblatt's work. Starting with this very first book, which was, you can be a stock market genius,

Starting point is 00:38:07 which I think, and everybody says this, but I'm going to say it again, and I felt a bit bad doing it. But it's a terrible name for a really, really good book. And that's a sort of, it's all about special situations, which is how Greenblatt ran his fund initially. And it's just such an awesome book. When I was a corporate advisory lawyer, I read that, and it just made perfect sense to me. And so that was the way I started out as an investor. In 2006, I found his little book that beats the market.

Starting point is 00:38:38 And that was a sort of similarly eye-opening experience when I read that. Because I had looked at what Buffett did, but his sort of business analysis was just too hard for a guy who, like I was, who's sort of a corporate advisory lawyer, but I think in terms of the financial filings and writing those filings, raising money and buying shares. So that was the actual business part of it. I just didn't have the tools to analyze. And so when I saw that Greenblatt was saying that it could be done in a quantitative fashion, that sort of appealed to me as something that I could do.

Starting point is 00:39:17 one very interesting thing that I saw pretty soon after that was a paper written by James Montere, who's another guy who I just loved to death. Montere was the guy who did the analysis of the little book that beats the market initially, and he said, if you take away the quality metric, you actually do better, which is completely counterintuitive, completely counterintuitive. And so that was one of those things that I thought maybe there is something more, to this is an area that I can study really closely. And so that was the analysis that we did in the first in quantitative value.

Starting point is 00:39:55 And that was really the genesis for deep value to dive into that idea and explore why it is that not looking at the quality or ignoring the quality factor, why that could lead to not only better returns, but better risk-adjusted returns, which makes no sense at all. And I think it's this idea of mean reversion that the quality is the quality factor that Greenblatt uses, the return and invested capital is really selecting for those companies right at the pinnacle of their business cycle and ignoring it, you do it a little bit better. Yeah. Let's take a quick break and hear from today's sponsors.

Starting point is 00:40:30 No, it's not your imagination. Risk and regulation are ramping up and customers now expect proof of security just to do business. That's why VANTA is a game changer. VANTA automates your compliance process and brings compliance, risk and customer trust together on one AI-powered platform. So whether you're prepping for a SOC 2 or running an enterprise GRC program, VANTA keeps you secure and keeps your deals moving. Instead of chasing spreadsheets and screenshots, VANTA gives you continuous automation across more than 35 security and privacy frameworks. Companies like Ramp and Ryder spend 82% less time on audits with Vanta.

Starting point is 00:41:11 That's not just faster compliance, it's more time for growth. If I were running a startup or scaling a team today, this is exactly the type of platform I'd won in place. Get started at vanta.com slash billionaires. That's vanta.com slash billionaires. Ever wanted to explore the world of online trading but haven't dared try? The futures market is more active now than ever before and plus 500 futures is the perfect place to start. Plus 500 gives you access to a wide range of instruments. The S&P 500, NASDA, Bitcoin, gas, and much more. Explore equity indices, energy, metals,

Starting point is 00:41:52 4x, crypto, and beyond. With a simple and intuitive platform, you can trade from anywhere, right from your phone. Deposit with a minimum of $100 and experience the fast, accessible futures trading you've been waiting for. See a trading opportunity. You'll be able to trade it in just two clicks

Starting point is 00:42:10 once your account is open. Not sure if you're ready, not a problem. Plus 500 gives you an unlimited, risk-free demo account with charts and analytic tools for you to practice on. With over 20 years of experience, Plus 500 is your gateway to the markets. Visit Plus500.com to learn more. Trading in futures involves risk of loss and is not suitable for everyone. Not all applicants will qualify. Plus 500, it's trading with a plus. Billion dollar investors don't typically park their cash in high-yield savings accounts. Instead, they often use one of the premier passive income strategies for institutional

Starting point is 00:42:49 investors, private credit. Now, the same passive income strategy is available to investors of all sizes thanks to the Fundrise income fund, which has more than $600 million invested in a 7.97% distribution rate. With traditional savings yields falling, it's no wonder private credit has grown to be a trillion dollar asset class in the last few years. Visit Funding, you know, RISE.com slash WSB to invest in the Fundrise Income Fund in just minutes. The fund's total return in 2025 was 8%, and the average annual total return since inception is 7.8%. Past performance does not guarantee future results, current distribution rate as of 1231, 2025. Carefully consider the investment material before investing, including objectives, risks, charges, and expenses.

Starting point is 00:43:39 This and other information can be found in the income fund's prospectus at Funds. dot com slash income. This is a paid advertisement. All right. Back to the show. So Toby, I can't help of wondering. Now you're saying that we don't have

Starting point is 00:43:54 to look too much about quality, but say that through our stock screen and we found 10 great companies based on the Acquire's Mostable, do you make any kind of analysis in terms of it doesn't look like that they will make money next year because they have

Starting point is 00:44:10 something's happening? Or is it just pure numbers? Is that what you mean by when saying quality? Or do also, yeah, again, look for the next 12 months? There are lots of different quality is, I try to keep on defining it as return and invested capital because it can mean a variety of different things. In a business quality sense, if you're Buffett, he doesn't really care what the return on invested capital was last year.

Starting point is 00:44:36 He's looking at a company that's able to sustain a high return and invested capital in the future. and he's using his sort of phenomenal mind and decades and decades of experience looking at these companies to determine which are the ones that can do that and which are the ones that can't. So I'm not talking necessarily about that method of investing. I'm just saying that when you're looking at the deep value ones, so one quality metric that you might like to look at is earnings quality. It's definitely you paid to find companies that are actually generating earnings. that are actually generating cash flow that matches the accounting earnings. So any company that's not got matching cash flows for its accounting earnings over a period of time is not a good company.

Starting point is 00:45:25 That's an early earnings manipulation indicator, and that's something that could potentially become a fraud if they're – so you want to avoid those companies for the most part. But the thing is when you're buying these acquires multiple, cheap on an acquire as multiple basis. The reason that the metric works so well is that it is looking for a very cash-rich balance sheet. It sort of favors companies

Starting point is 00:45:49 that have got a lot of cash on their balance sheet. So you're not paying a lot for the actual residue of the business that you're buying. So you're not paying a lot for the market capitalisation. There's probably no debt there. And then there's very strong operating earnings in relation to that residue that you're actually paying for.

Starting point is 00:46:05 So you're sort of already self-selecting for the kind of things that they've got plenty of runway if they've got cash on the balance sheet so they can withstand a down period and then they perform quite well at the other side. Because the assets are all liquid at that point. Go ahead, Sting.

Starting point is 00:46:20 Yeah, and just one thing to say, I just checked Toby's website before the interview and he's going through this formula. So if you think it's quite hard to understand, it requires multiple, we're talking about cash, we're talking about liabilities. I think the best thing is really to go into Tobis site and take a look at his formula

Starting point is 00:46:38 where he explains, like, how he derives, this number. So I just want to put that in. Acquireosmultable.com, A-C-Q-I-R-E-R-S-Multible.com. So real fast, just so people understand, when you're talking Acquires Multiple, so if you were a guy like Carl I-Con, and you can go in and buy a very large chunk of a business, he's not looking at the market capitalization, which is basically your share price times the number of shares that are outstanding. He's not looking at that number because that's not really telling him what he'd have to pay to own the business. And that's a big misconception that a lot of people have. What is the real number is this acquires number that Toby's referring to. And that's your,

Starting point is 00:47:17 that's your EV or your enterprise value. Okay. And that's where you're taking that market cap that everyone thinks is the number they've got to pay. You're adding in the debt and the minor interest and the preferred stock and things like that. And then you're subtracting out the cash. And that's giving you the real number that you'd have to have if you were going to buy every share of the business. Okay. So he's saying using that compared to the earnings before income tax, is a much better representation of the PE ratio than the PE ratio. So that's what he's saying in all this. But anyway, Toby, I think that was our last question.

Starting point is 00:47:51 I just want to turn it over to you. If people want to learn more about you or your book or your websites, how can they find out more about you? And whatever you tell us, we'll make sure we have in the show notes so people can access it quicker. I have a blog called greenbacked.com, which is G-R-E-N-B-B-A-C-K. kd.com.

Starting point is 00:48:12 And I put all of my research up there. There's 800 kind of posts going back to 2008 when I started writing it publicly. And you can sort of see all the research that I've canvassed. Then, of course, there's deep value and quantitative value where we've got all the research together in a sort of coherent fashion and written about it. So it sort of makes sense. And then I have a website, Acquireasmultable.com, where I just, I run the screen.

Starting point is 00:48:41 It's updated every 15 minutes, and we'll just show you the best opportunities in a very large capitalization universe. And in all capitalizations, so all investable, I call it, which is sort of the largest two-thirds of U.S. stocks. And then it's small and microcap. And I have another service called Singular Diligence, which is a research service looking at, looking for Buffett-style stocks. So we focus on a single stock every month, and then we write $12,000. words about the business across nine articles and where there's lots of charts showing the very important ratios of most important relationships for that business. And we produce that once a month. And so they're sort of best for buy and hold investors. Absolutely amazing. All right. So

Starting point is 00:49:28 this is the point in the show where we're going to play a question from a member of our audience. And this week we're going to play a question from Stephen McNeil. And we're also going to invite Toby to help us answer Stephen's questions. So here. Here's Steven's question right now. Hi, my name is Stephen, and I'm a big fan of the podcast. My question is, is there ever a time where a high PE ratio, say 30 or 40 or higher, is justifiable to the value investor? Does a number this high signify too much speculation, or can a higher PE ratio sometimes

Starting point is 00:50:02 be okay? Thank you. All right, Stephen, thank you so much for the question, and we're going to have Toby take it away. That's a great question. I'm very happy to take that. So I know lots of value guys. And most of my friends who are value investors running little firms, they tend to be Buffett-style guys. And we have these debates all the time. So it's kind of interesting to talk to somebody about their process. So my process, like I was saying before, if I run the model and I look at the companies that are in the model, I feel sick because you're buying oil and gas. You're buying oil and gas. That's just a terrible idea at the moment. I don't know where oil and gas oil is, but it could be, it could just as easily be cut in half again from where it is now.

Starting point is 00:50:50 And I know that Dan Lowe came out yesterday and said that it's just all the tourists who are buying the oil and gas companies. So I'm a tourist buying oil and gas companies. So that's my process that I just ignore the businesses that are in there and just buy them and don't worry about it. So this friend of mine who's a Warren Buffett-style guy, his process is he goes through and he does his full valuation and then he doesn't look at the implied PE of his intrinsic value calculation because frequently he will say that the and he gave me an

Starting point is 00:51:24 example of something that was on 40 times earnings and he said if I looked at that and I saw that the implied PE was 40 times then there's just no way that I could buy that company because that's way too high so his little trick is not to look at the implied PE so I think the answer is that yes, you absolutely can buy those companies if the valuation is warranted. As a deep value guy, I'm sickened anytime I hear a number that high, but he definitely doesn't. And, you know, I think if you would look at, you can always provide the example of a company that would have a high P.E. that then shoots into the stratosphere even further, like Apple,

Starting point is 00:52:01 for example. You go back into like the 2003 time frame, somewhere around in there, where whenever they really started taking off and people were trading them higher. I think it was maybe 2004 or five or whatever. But that would be an example. That would be an outlier to a lot of the stuff that we're talking. But I think your research is done on a large quantity or volume of data points. And the data points definitely prove that a higher PE ratio performs much worse than a lower one. So I think it really depends on your approach. If you're buying onesies and twosies and you think that you have the acumen like Warren Buffett to go ahead and find that diamond in the rough that's a great business that might not have people really looking at the value, the hidden value that's actually there through competitive advantage and stuff, well then go ahead and do that.

Starting point is 00:52:52 But if you're investing across an index of stocks or a larger portfolio, I think Toby's book would really be eye-opening for a lot of people when they look at. a high PE ratio type pick. The other point to make too is that when I'm looking at on an acquirers multiple basis, I don't actually look at the, I don't know whether there actually are any earnings that are falling to the bottom of the income statement there. So it's entirely possible that they have quite a good operating earnings figure. And it's just eaten up through some other part of the income statement. And so the number that falls to the bottom is not really representative of,

Starting point is 00:53:32 of the operating earnings that are coming in. So even though it's cheap, it might be three or four times on an acquires multiple basis. It could be because the E is so small that it could be 40 times or it might just be, you know, the, it might be ref. If you look on your Excel spreadsheet and there are no earnings, you get the hash ref. That's how I know it's gonna be a good one

Starting point is 00:53:52 when I get the ref for the P.E. number. Toby, I got a question for you. So have you ever spent much time looking at the look-through earnings piece of Berkshire Hathaway and trying to find other businesses that have that piece of it, that look through earnings piece, because I think a lot of people misvalue Berkshire Hathaway simply because they do not understand look through earnings. I haven't spent a lot of time looking at Berkshire's look through earnings. I'm interested, though.

Starting point is 00:54:22 So what's the analysis that you're doing? So here's the idea. Whenever I was looking at the cash flow of Berkshire Hathaway, the, the, the, the, amount of money that shows up on the businesses that he doesn't have a controlling share in. So Coca-Cola is a perfect example. The only money that actually shows up and that's reportable on his income statement is the dividends that are paid. But whenever you look at the actual earnings that Coca-Cola is making, it's on the magnitude of basically taking that dividend payment and probably multiplying it by three as to the real earnings or the look-through earnings that Coca-Cola is really

Starting point is 00:54:58 making. He doesn't have to list that anywhere on his balance sheet or income statement. Okay, now it'll show up eventually on his equity line of his balance sheet as unrealized gains, but when people are trying to look at the value and their forecasting future cash flows, I would imagine 99.9% of the people out there do not include that extra money that's not being showing up anywhere until it actually materializes. So what I, what I'm trying to do, what I'm trying to do more research on is I'm trying to understand look through earnings for other businesses outside of Berkshire Hathaway. Because whenever I look at Berkshire Hathaway's reported earnings, their P.E. ratio, like

Starting point is 00:55:41 Berkshire right now might be, I don't know, like a 17 or something like that. When you account for look through earnings, its P.E. goes down dramatically to maybe a 12 or maybe an 11. And that's something that I think everybody misses the boat on. And I think that's why Berkshire Hathaway has continued to be traded at such a low multiple when you look at like the price of the book and things like that. But I think if people actually understood look through earnings, they would see a lot more value in businesses that are similar to Berkshire Hathaway as far as holding companies. So I'm trying to find a person out there that, A, understands what I'm talking about. And I can see by your reaction, both you and Stig are totally catching what I'm talking about.

Starting point is 00:56:24 You guys understand what I'm saying, but I just haven't had the right person to have the quantitative analysis, the skills that you have with obviously in your book, to kind of dig into this and discover more about it. So maybe it's something we can talk about offline, but I just wanted to bring that up because most people I talk to look at me like I've got crabs crawling on my ears whenever I talk about that kind of stuff. It's a sum of the part style analysis where you're looking at the underlying. businesses that the business that you're buying, the company that you're buying holds.

Starting point is 00:56:58 So I can think of AGCO is one at the moment. It's cheap on an acquires multiple basis and it's got an Indian subsidiary that's not included at all in that calculation. And so it's a lot cheaper than it looks. Those are the sort of things that deep value guys love to find because they're, you know, that's a business that's saleable that has some value there that is not at all included in everything. it's visible in the financial statements. So yeah, I think that's a great analysis.

Starting point is 00:57:28 It's really interesting because it's a shortfall of gap. It really is. It's an accounting issue where because it's a non-controlling share of a business, he doesn't have to report it. And that's really where the gap kind of falls. And I think a lot of people miss the mark. And when you look at Berkshire, I mean, he has such a large amount of his business is in a non-controlling share of all these other business. I want to say it's in excess of $100 billion for Berkshire, which has, you know, I mean, that's what, one third of its overall market capitalization value is all in a non-operational subsidiary business. And so when you would, let's just say that the mark is $100 billion, and his dividends on that $100 billion would probably be around the $3 billion mark, okay?

Starting point is 00:58:15 I would argue that there's probably another $6 to $7 billion that he's actually making, that he doesn't to report anywhere or show up because they're non-operational subsidiary. So there's a lot of value there that no one's seeing. And I think that's why you see it's priced a book at like 1.3 or whatever it is right now. But anyway, Toby, thank you so much for answering the question from our member from the audience. Thank you so much for coming on the show. And I'm telling you, I will treasure this book. I am like really enjoying this book. It'll be one of the ones that I keep on my shelf right next to security analysis. And it's causing me to really rethink a lot of the different things that I'm doing. And it's going to give me some opportunities to test some

Starting point is 00:58:53 new stuff out. So everyone in our audience, thank you so much for joining us. We're going to send a free-signed copy of the Warren Buffett accounting book to Stephen. And we're also going to send a free sign copy of our book to Glenn for recommending Toby for coming on the show today. So Toby, thank you so much. And we'll see everybody next week. Thanks for listening to The Investors Podcast. To listen to more shows or access to the tools discussed on the show, be sure to visit www. com. Submit your questions or request a guest appearance to the Investors podcast by going to www. www.com. If your question is answered during the show, you will receive a free autographed copy of the Warren Buffett Accounting Book. This podcast is for entertainment purposes only.

Starting point is 00:59:37 This material is copyrighted by the TIP Network and must have written approval before a commercial application. Thank you.

We Study Billionaires - The Investor’s Podcast Network - TIP 025 : Deep Value Investing - w/ Tobias Carlisle (Investing Podcast)

There aren't comments yet for this episode. Click on any sentence in the transcript to leave a comment.