We Study Billionaires - The Investor’s Podcast Network - TIP165: Tobias Carlisle and The Acquirer's Multiple (Investing Podcast)

Starting point is 00:00:00 You're listening to TIP. All right. So in today's show, we bring on our good friend Toby Carlow to talk about his new book, The Acquires Multiple. Toby has conducted extensive research on Warren Buffett and Jewel Greenblatt's magic formula, along with numerous other successful quant investing approaches. Based on back testing of historical market results, Toby explains why his Acquires Multiple Approach might even capture a couple more percent than Greenblatt's approach. For people not familiar with Toby, he's the founder of Carbon Beach asset management, and he's an authority in the value investing community. And during the episode today, we talk about what the enterprise value of a company is and why it might be useful for finding good stock picks. All right. So if you guys are ready, let's get started. You are listening to The Investors Podcast, where we study the financial markets and read the books that influence self-made billionaires the most.

Starting point is 00:00:56 We keep you informed and prepared for the unexpected. All right. We're really excited to have our good friend Toby Carlow with us. And Toby, I wanted to personally thank you on the show because I don't know that we talked about this, but I wanted to thank you for coming out to the New York event that we did back in August, flew the whole way out from California. Just wanted to personally thank you for coming out to the event. I know a lot of people that came out to it really enjoyed seeing you as well. Hey, thanks so much for having me back to the show, guys.

Starting point is 00:01:32 And I absolutely love that event. The highlight of it was meeting so many great. people, but the highlight of the highlight was getting that poor Charlie's almanac signed by Charlie Munger, honestly. So Toby, let's cut to the chase here. So you got a new book that came out. And we're really excited to talk to you about this. But one of the questions, we opened up the questions to our audience over Twitter.

Starting point is 00:01:55 And one of the main things that people were asking us was, what's the difference between your new book, which is called The Acquires Multiple and your last book, Deep Value. What's the differences between those two? Deep Value came out in 2014, and Deep Value was this quasi-academic, long, kind of dense book on the mechanics of mean reversion. I found that as I handed it to a lot of people, I got two main complaints. One was that it was hard to read, and there was a lot of jargon in there, sort of unintentionally. It's just one of those things. When you're doing this stuff all the time, you sort of forget that, you know, somebody who's smart might not necessarily know what EBITDA or operating earnings or enterprise value is.

Starting point is 00:02:33 So I wanted to write a book for my family and friends who were interested in this stuff but weren't necessarily what I would call stock market people. They're not doing it all the time. So my mum and dad and various other people. Look, and it's not dumb down at all. I saw that criticism on Twitter. The point of the book is not to be dumb down at all. It's, you know, I think that you can see people trying to hide weak ideas in high language.

Starting point is 00:02:58 I think that the ideas are strong enough that I wanted them to be communicated to a very broad group of people who aren't necessarily just stock market people. If you're a smart person and you don't have a lot of a background in this stuff and you want a nice kind of entree into it, then I think this is a great book to start off with because it explains the terms. It explains the kind of the argument in the value investor community between the sort of Buffett type guys and the guys who are more deep value, which is what I do. Great. And Toby, really excited to dig more into the approach here later on the show, but the first question I have for you is really to talk about you and in your journey as an investor to find the right stock investing strategy for you.

Starting point is 00:03:41 When I was in my undergrad doing business, I read security analysis. I found it really, really hard to read. I found I read the first edition of security analysis because I thought that's going to be the one that he put all the really juicy stuff in before he sort of got the chance to edit it as he went along. I found it really, really hard to read. I don't even know if I got all the way through it, but I did get to the liquidation chapter because I was sort of really interested in the net nets. I had kind of heard that that's what Graham did. Then I went to law school and I started working as a lawyer and I was doing mergers and acquisitions, capital raising kind of capital market stuff in Australia and in the US.

Starting point is 00:04:16 And just because of the time that I came out, it was the early 2000s, lots of these companies that had raised a lot of money in the late 1990s now were trading really cheaply, like below their cash and these activist investors, I don't think they were even called activist investors, like nobody really knew what they were. They were just sort of corporate raiders from the 80s, but that wasn't the term that people were using. They came in, they tried to get these companies to pay out the cash. I was looking at them and I was looking at the businesses, you know, to the extent that these companies even have a business, which often they didn't, they were just sort of trying to attract eyeballs, trying to work out what they were doing.

Starting point is 00:04:52 And I couldn't figure out what they were doing. And I remembered that Graham had taken that approach. I went back and had a look at it and then it just sort of, it became a little bit clearer. And I thought, next time that this happens, next time the market gets this cheap, I will remember this and I'll go in and I'll start buying these little sub liquidation value companies where there's an activist. And that was, that was green backed, which was the blog I started writing in 2000. And I picked those kind of stocks. They all did really well. Pretty quickly, you find that the problem with that strategy is that the net nets just aren't around all the time. They're sort of, they're like some sort of animal that only comes out every seven or eight years when it's like a cicada

Starting point is 00:05:30 or something like that only comes out very occasionally. So I was looking for something that embraced that kind of idea of looking at the balance sheet as well as the business. And I had read some stuff in my undergrad business about leverage buyouts. And I went into those old books which were in the social science library at my university. And I went through them and I found all is old, you know, from like the 70s and 80s and 90s about the buyouts. But that's the idea. So it's the acquirers multiple basically is a way of finding very deeply undervalued companies with sort of hidden cash on their balance sheets, good operating earnings relative to what you're paying. And then they're the sort of things that attract private equity firms and activists

Starting point is 00:06:13 who can get in and do something with the business. So Toby, I guess I'm curious, why do you think it made sense to you because I'm sure a lot of people out there who are listening to this on like, yeah, that kind of makes sense that you will follow an activist or see if they have hidden cash on the balance sheet, but it also sounds very technical to identify. So why did it appeal to you? Well, what I did find is that a lot of the time they're just undervalued and it's mean reversion that pushes them up to valuation. But I think, you know, you have to be doing this sort of stuff if you're a discounted cash flow investor, if you're a Buffett compound You need to be doing this kind of analysis anyway.

Starting point is 00:06:51 I think the difference is what I do is I recognize my own limitations when I'm looking at a business and valuing a business. It's very unlikely. I think that I'm going to have any kind of insight that any other person out there who might be a professional in the industry or might be have a background as a consultant or an investment banker in the industry who might be able to have a better idea about where that industry is going or where that particular business is going. So I want an approach where if I assume that I don't have any sort of unusual insight into the business that might give me an edge, how can I still protect myself and still do fairly well investing in these stocks? And I think that the way that I do that is I just try to buy them very, very cheaply, hoping that you get this sort of asymmetric return where a lot of the downside has been taken out of it. And if something good happens, you get a lot of upside. So, Toby, in your book, you talk about Warren Buffett's early days. I think this was in the second chapter. You reference a quote where Buffett said, and this is a really popular quote that a lot of people throw out there all the time. Buffett said that he could get a 50% annual return if he was managing smaller money around like a million dollars. So from that, you teach people that Buffett would split his investments into three groups back whenever he was first starting out with a small sum of money. So talk to us about this idea and what we can learn and take away from this. And,

Starting point is 00:08:13 Can you identify those three groups that you reference? The three groups are generals, which is something that is just undervalued, with no sort of clear path for the undervaluation to be removed. Like there's no catalyst. It's just the sort of, you might go and do a valuation, find that it's undervalued. Think that over time it should do okay and the valuation should sort of go back to average. The other two are sort of both, they're related to each other. It's a workout and a control situation.

Starting point is 00:08:41 So a workout is just any special situation. I've been on the show before talking about special situations, but that's basically there's a known catalyst, which might be a big share buyback or a spin-off or a liquidation or some event where the decision is made at a board level to bring the valuation back in line. And so that's how you extract the value from it. And there was a smaller group of that workout group where Buffett was the guy

Starting point is 00:09:06 who was in control and he was going to make that thing work out. He was the one who was going to make the company, spin-off or pay some money out or liquidate or whatever. When he was doing his workouts, he often said he was very happy to be a coat-tail rider, where he was on some other good investors' coat-tail, where he was confident that that person was going to do what he would do if he was in control. So those are the three groups, workouts, control situations and generals, and coat-tale riding or control was the way that he executed them. So on and off the show, Preston and I've been discussing what is a good return.

Starting point is 00:09:41 And this is for an investor picking individual stocks. Because given high market valuations, I guess that one could argue there's something like six to eight percent return. If you can get that over the next decade, I think a lot of people would say that's fairly decent. And then you also have the other side of the coin where it's like you might even be able to get a higher return if you don't invest in the stock market right now because it's so a value, you might wait for a crash and then jump into the market.

Starting point is 00:10:10 So, Toby, I'm not going to ask you to predict when the next market crash will happen. Don't worry, that's not the point of this question. I guess I'm curious about your thought process about how to achieve a good return in the stock market without taking on too much risk or if you would just rather stay out of it. Yeah, that's probably the most difficult question that you could ask anybody. I know exactly when the next crash is coming, but I just, I can't tell it. I'm giving it to myself. James Montere wrote this great article for GMO a few years ago saying that we're in this

Starting point is 00:10:47 very difficult position where you either have to be fully invested earning low returns or you may be able to get the sort of stock market has been pretty strong over the last few years, even though it has been quite expensive. But you run the risk if you're fully invested of having a big drawdown, which is what Buffett and Munger always say too. If you're not prepared to have a 50% drawdown, you shouldn't be in the market. or whatever proportion of your money you're not prepared to have go down that much, shouldn't be invested in the market.

Starting point is 00:11:14 But the other problem is that if you don't then want to take that risk, the risk that you take is that you sit in cash, which is earning nothing for a really, really long period of time. How long is it going to be before there's a crash? I have no idea. So to answer the question, what's a good return? In the early 80s, the market could have been expected to do something like close to 20% a year and I think that's what it delivered.

Starting point is 00:11:39 I think if you look at what the valuations imply now, the returns are going to be much, much lower than that. I think 2% is probably what the market's going to do. If you can get a little premium over that by investing in value, because I think that value has underperformed a little bit. I do think it's got a little bit more outperformance than the market does in it. The extent of that outperformance, I can't gauge. But value has some properties that make it a little bit less attractive than the market.

Starting point is 00:12:06 So you need a little bit more return. I would say, I mean, I don't want to really want to put a number on it, but a good return over the next decade would be, I agree, 6 to 8 percent, but I don't think that's what the market's going to do. The market's going to do, too, with a big drawdown in between. 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. 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.

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Starting point is 00:16:32 the opportunity to log in 7% return all the next decade. For you, being a far better investor than the average, I know this again is a reasonable question. Do you think that's a good return for you? That's a really good question. I want my money to invest in my own strategies, but do I think that I can beat 7%? For no risk, it's 7%.

Starting point is 00:16:53 That's getting close to the number that I'd probably have to say, maybe I'll just go fishing. That's your hurdle rate for right now. I think it's, I think being realistic, I think that's, you know, Because you're guaranteeing this too, right? I don't have any counterparty risk in this trade. I mean, I think that's a good return, but you can't get that anywhere.

Starting point is 00:17:08 That's not a return that's available anywhere, risk-free, guaranteed. Yeah. So, Toby, we throw around this term enterprise value a lot on the show. So I would like you to describe to the audience what is enterprise value so they understand what the terminology is. It's a great question. And it's just one of those things that you have to learn one time so that then you can, you remember just in very broad terms. The market capitalization of a company is its share price multiplied by the number of shares that it has outstanding. But that doesn't tell you the whole story about the company because companies can have a lot of debt or a little bit of debt.

Starting point is 00:17:48 They can have cash. They can have other types of shares, preference shares, and they can have unusual things like minority interests or other kind of liabilities like underfunded pensions. So what the enterprise value does is it approaches the, company as if it's going to be taken over in its entirety by an acquirer. And when they do that, they have to be prepared to support the debt. They're able to get access to the cash. So you can have a company. And these companies really do exist on the stock market.

Starting point is 00:18:19 It might have $100 million in cash. It might have a market capitalization of $50 million. The enterprise value of that company is negative $50 million because you're in effect. You can get access to that cash. Now, the reality is that when you find companies like that, they have terrible businesses or they have no business and they're just burning cash. It's like a biotech trying to find a compound or trying to get FDA approval. On the other hand, you can have an enormous amount of debt with a small market capitalization. So it might be a $50 million market capitalization with $200 million in debt.

Starting point is 00:18:53 And if you only look at the market capitalization, you're missing that debt, which is a real cost that the acquirer has to bear. So it's something that you have to bring into the equation. The enterprise multiple is just a simple step for sort of bringing all of those things into one little quick analysis so you can see what you're paying and then you can compare it to what you're going to be getting. So in really simple terms, when we're talking market cap and let's say that we have 10 shares of a company and each of those shares is $10. The market cap would be $100 because you're just multiplying those two numbers together. If you're talking enterprise value, now you actually have to add the debt in there as well. So it's the market cap plus the debt is your enterprise value whenever you're figuring out. Is everything that I just described accurate, Toby?

Starting point is 00:19:39 100%. Okay. So what's nice is when you're looking at the enterprise value, you're accounting for the debt piece of it. You're accounting for, you know, Stig and I talk about debt to equity and some other leverage ratios that we'd like to throw out there. But when you're talking enterprise value, you're accounting for that in the market price that you're talking about. So now talk to us about backtesting and what it suggests. And after you talk about the back testing that you've done, talk to us a little bit about comparing your backtesting results to Jill Greenblatt's back testing results.

Starting point is 00:20:09 For anybody who doesn't know who Joel Greenblatt is, he's a professor out of Columbia University, very famous investor. I want to say his net worth's close to 900 million or something, 700 million. It's way up there. And he's had enormous returns. And Toby has some back testing results that are quite interesting. and I'll let Toby describe it to you guys. I'm a huge fan of Greenblets, and I have been for a very long time.

Starting point is 00:20:31 He wrote this wonderful book more than a decade ago now, which is a book about special situations. And that was how I first found out about Greenblatt, because it's sort of appealed to me as a lawyer, but it's a difficult book to read, and it's a difficult strategy to implement about a decade ago, a little bit over a decade ago. He wrote The Little Book that Beats the Market,

Starting point is 00:20:47 which is probably the most successful value investing book of the last decade. The little book describes this strategy called the Magic Formula, which he found by reading through Warren Buffett's letters to shareholders, and he found that Buffett sort of advocates these two ideas, a wonderful company at a fair price. So a wonderful company is something that earns a lot of money for each dollar invested in it, and a fair price is a low price relative to the operating earnings of that company. He combines them together to get the magic formula.

Starting point is 00:21:20 And then when he back tested that magic formula, he found that it outperformed over the period that he tested it, which might have been sort of 1993 to 2005, something like that, which is the period in the book. I thought it was a fascinating strategy and I read the book in 2006 and I loved it. I have this bias for deep value and I just had this question, this sort of nagging question, is this buying these companies right at the top of their business cycle? Because the distinction between what Greenblatt is doing and what Buffett is doing is Buffett is looking for sustainable high returns and invested capital, whereas the magic formula is just looking for

Starting point is 00:21:57 high return and invested capital at the time that they screen for it, it's much, much harder to find that sustainable high return and invested capital than it is to find a company just having a good year. So it turns out that if you just remove that requirement for the high return and invested capital, you get better returns. And that's essentially what the acquires multiple does. It just says, let's ignore what the return and invested capital for the company is. And let's just make sure that the company is cheap and has pretty good operating earnings. And it turns out that when we test that idea, you do get better performance than the magic formula in a back test, even though the magic formula does tend to beat the market. By how much, Toby?

Starting point is 00:22:37 It varies depending on the universe that you're looking at. It's a material number. I'm always a little bit worried about giving the precise numbers because it's a little bit meaningless because there are so many different inputs and ways of doing these back tests. For the acquires multiple, I asked this machine learning value investment firm based out of Seattle called Euclidean Technologies to do the back test for me. And I gave them the instructions that the back test should look the same as the one that Greenblatt conducted. And then I showed them my own strategy. And I said, can you test both of those? And they did that.

Starting point is 00:23:10 It's a few percent a year by ignoring the invested capital. Interesting. I'm really glad we're talking about this, Toby, because whenever we're. we are back testing, I think a lot of people would say, will this work in the future? And perhaps this question is more relevant than ever giving artificial intelligence and machine learning that you're talking about too. And how would this look in the future? Everybody knows about these strategies. It's not knowledge of these strategies that is the limiting factor in the application of them in the real world and investment. The thing that makes these strategies difficult to invest

Starting point is 00:23:47 in is because they extract a certain amount of pain from you as someone who's invested in them. And the way that they do that is basically this thing called tracking error, which is kind of the fancy academic term for not keeping up with the market or going down when the market's going up. That's really painful. That's something that any kind of value investor has experienced on and off pretty regularly for it since value investing was invented, but certainly over the last seven years because values sort of struggle to keep up with a very strong market. So that's sort of the answer. Value strategies are always necessarily going to be strategies that can't get as much money into them as other passive strategies or other kind of momentum style strategies. And they have

Starting point is 00:24:32 this periods of underperformance that make them unacceptable to many people who would want to invest in the market. And that's sort of what keeps the performance there. Interesting. So basically, what you're also saying here is that even if you had a fund doing artificial intelligence that I guess would, I guess for a fund like that would probably be easier to attract capital than saying, I'm buying the Oculus business. Which is basically what you're doing with deep value and then wait for the performance. A fund like that couldn't survive, even if you called or something else, because if they were chasing that deep value outperformance that you're talking about, people would little by

Starting point is 00:25:07 little just take out the money whenever they see continuous underperformance for a period time. You know, it's very hard to know whether the reason for the underperformance is that the strategy doesn't work or if it's just going through one of its sort of periodic underperformance times. And it's that point where everybody just says, this stuff no longer works. I'm getting out. When value investors look their dumbest, that's the time that value, I think, is generally about to start working. All right. Interesting takeaway. So Toby, I'm super excited to ask this question of you. I've really been looking forward to it. We've been following Redalia for a long time here on the show. And him and also other great investors, they're talking about how important it is

Starting point is 00:25:52 to have 15 uncorrelated bets with a low downside and a high upside. And he specifically, they're into different asset classes. Now, whenever I'm speaking to you and also reading into your material, whenever we're talking about these Xx returns, they come from buying a basket of the third of the cheapest stocks. I'm curious to hear how diversified you find that bet. And specifically with the uncorrelated part, Toby, because I'm curious to hear that part too. The guys like Dahlia, who are global macro-style investors, can find in lots of different markets that there are uncorrelated bets.

Starting point is 00:26:32 So they might be able to find some particular trend following commodity strategy, value investing equity strategy, momentum equity strategy. And they might be able to find that they might be doing it long, short as well. And they find that if they put them all together, because you can sort of rebalance the portfolios at different times. So when one's losing, you can take away some money from one that might be winning and feed it to the one that's losing. And you can get a sort of smoother return by putting these uncorrelated bets together.

Starting point is 00:27:03 value is a component of that, but it is not an uncorrelated strategy by itself. You know, the way that you can sort of get some of that impact is by holding some cash. And when value is going very well, you take a little bit of money away and you increase your cash holding. And when values going worse, you take away from your cash holding and you invest more into the stocks. Value investing does have its sort of own idiosyncratic return path that doesn't exactly follow the market. That's a little bit of that tracking error that we were talking about. before, and that's a tracking error is actually indicative of strategies that work. If they have more tracking error, they tend to do better.

Starting point is 00:27:39 It's just it's a painful thing to go through when they're underperforming. But they are quite correlated with the market just by virtue of the fact that it's a long equity strategy and the market is also a long equity strategy. So there is some correlation and it varies depending on its lower correlation now because the market's doing so well and value has been underperforming. But there are periods of time where the correlation's won. And if we go into a big enough crash, the correlation will be one, which means that it'll be going down the same speed as the market. Is it a problem that it's not as diversified? And I think my question gets at how do you look at diversification? Are you more like looking at this as, you know, it's 30 companies and they're real companies. It's not an asset class in itself that there are stocks. So you don't need necessarily to diversify into bonds, goals, whatever we want to call it. Is that how you see it?

Starting point is 00:28:30 I want to piggyback on Sticks question. question, Toby, because he threw out the number 30, but from all the things that we've read from Greenblatt to Dalio and other people, they're saying that the number's 15. So I'm kind of curious if you, the number part of it as well. Well, there's two questions there. There's, what Dalio was talking about is uncorrelated strategies. So he's talking about a value investing strategy with a momentum strategy, with a trend following commodities, futures strategy, maybe with an option strategy, you know, maybe an international equity spawns. It's a global macro type of approach.

Starting point is 00:29:04 The diversification is a slightly different question. Are you holding enough stocks so that if any one of those stocks goes to zero, will your portfolio sort of survive? And that's a question that when I wrote concentrated investing, that's exactly what I was trying to dig into in concentrated investing. It's one of those times when the academic literature and the sort of rule of thumb from old school value investors basically coincide. So if you ask the academics, they tell you that 30 stocks, somewhere between 20 and 30 stocks gives you enough diversification, where if you try and buy a whole lot more stocks, it's just become too expensive and too hard to manage for the additional diversification

Starting point is 00:29:42 that you get fewer than sort of 15. And by adding an additional stock, which might not be that much more expensive, you do get sort of a material improvement in your diversification. But the old school value investors like Graham and Clam, and they'll tell you it's approximately the same number. It's around sort of 20 or 30. You know, if I could find 14 uncorrelated bets, I don't know, that would probably make me a global macro guy. I think I've conquered one, or maybe I haven't even conquered one. I've just been trying to understand one, and that's sort of all I'm capable of.

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Starting point is 00:33:37 So the reason why I am really asking into this is also that right after reading deep value, I read extensively about rate value. And it was really interesting to go through your work and think about stocks. not just stocks in itself, like the worst stocks you can ever think of and how they outperformed and how you still might get that sense of managing your risk, because after all, you did have 20 or 30, whatever you want to call it, so that it wouldn't just be one company that would go bankrupt. Then afterwards, you would be reading about Redallion, how he's talking about not just US stocks, international stocks, international bonds, he was talking about gold, he was talking about

Starting point is 00:34:17 commodities and talking about how important diversification is and how that is, if not free, then one of the best ways of mitigating your risk without compromising too much on your returns. What's your thought process of doing something like that compared to your own strategy? That asset allocation question is often one for individual investors and they can allocate to a value investing strategy or a market, you know, just a passive market strategy. the things that Ray Dahlia are doing are driven by the fact that he's got $100 billion under management and he needs a sort of fairly exotic, sophisticated approach to attract that $100 billion and then to put it to work. He's got a whole lot of guys out in Bridgewater who are working these strategies all the time.

Starting point is 00:35:03 I'm an old school value investor who I think I can sort of value a company and I know the reasons why it underperforms and I know the reasons why it outperforms. So I sort of feel like I know it well enough that I can just sit in it and let it run. All right. So Toby, this next question comes to you from Ted Darling on our Twitter feed. And he asks, do you get rid of stocks with a high amount of short interest from the acquires multiple filter? Is there an additional filter layer where you're trying to extract picks that just are really uglier than ugly? The website screener takes a lot from the book quantitative value where we sort of, of went into the mechanics of screening. And there are lots of different things that you can do.

Starting point is 00:35:47 You can look at financial distress risk, earnings manipulation by itself and also as sort of a guide to their potentially being fraud. And there are lots of statistical ways of doing it. So I use those statistical methods to filter out particular types of stocks. I also use short interest as a way of identifying things that maybe I can't figure out where the risk is or the statistical methods haven't quite got there, but the short sellers have been able to identify that there is something going on there that's not quite right. The reason that I do that is that heavily shorted stocks tend to underperform. That's what the research shows us. That doesn't necessarily mean you want to go and short them because by virtue of the fact that they're

Starting point is 00:36:31 heavily shorted, that means that the borrower can be quite expensive. But for a long investor, if you're approaching these things quantitatively, not buying the things that are heavily shorted seems to be a way to add a little bit more performance. So I do filter out the things that are heavily shorted. I don't use a fixed hard cutoff. I just say that the 5% of stocks that are currently the most heavily shorted and its short interest as a proportion of their outstanding flood are the ones that we don't want to look at. So something can be cheap undervalued on an acquirers multiple basis and should be in the screen and it can appear in the screen and then the short interest might build up in the stock because somebody's got a view about the

Starting point is 00:37:10 fundamental picture or something else that's going on. And so it'll come out. Often they come back after a while, the short interest is sort of leaked out and they've recently settled down at a low price, but I definitely use it. So I'm curious, is there a reason that you settled at 5%? Was there some statistical evidence that supported a 5% versus 10% or 15%? Well, you've got two problems. There needs to be enough stocks sort of getting through the filter to allow the ranking methods to do their job, because for the most part, the cheaper something is the better the performance over time. But you equally don't want things that are too heavily shorted.

Starting point is 00:37:46 So 5%, I can't remember whether that gave the best performance or not. I'm not entirely sure, but it just felt like when I ran, often this is what I do. I'll run a screen and I'll look at the things that have been pulled out. And I'll just look at the names and see if those are names that I would feel uncomfortable buying for whatever reason. And mostly, I'm more interested in sort of balance sheet issues than I am with business issues. It's a just that, again, that's my bias. I think I probably did two things.

Starting point is 00:38:13 It was probably looking at the performance and then looking at whether that was pulling out too many names and just sort of a rough roll of thumb. I thought that was the best approach. So this next question comes from Kieran McCarthy. And he's curious about your use of options with your investing strategy. We use options in our special situations portfolio, not in the deep quantitative value portfolio. The thing about options is they're highly leveraged instruments. So that means that they can generate a lot of return, and they're also able to blow gigantic holes in your portfolio.

Starting point is 00:38:50 So you need to be very careful when you're using them, and you need to sort of understand what they're going to do. The way that I like to do them is the way that Greenblatt described them in his little yellow book, and that's basically there are two ways. If something is very cheap and the volatility in the position is very high, you can sell a put and that creates a return profile that looks like being long the equity. I don't want this to be too technical, but basically your downside is an equity downside. So if you sell a put and it might have a dollar premium in it and it's a $10 stock,

Starting point is 00:39:25 your downside is the other $9. So you need to be careful when you're doing that. Another way of doing it is to buy a leap, which is a call option that has more than 12 months to run in it. And so you would do that if you felt the stock was really cheap and there was low volatility in the calls. It's something that I love to do when the premium is a very small amount relative to the price of the stock, because that means a small movement in the stock price, gives you a very large movement in the value of the option. But the reverse is also true.

Starting point is 00:39:56 It's a small movement down. A zero is entirely possible. So when you're using call options, you need to be aware that zero is a very real possibility. and when you short puts, you need to be aware that you can lose an enormous amount of money on those. So you need to be very careful with the way that you use them. How do you size, let's talk about the call options first, and perhaps intuitive that also makes slightly more sense. Basically, what you're saying is that you can just all go out the window. So obviously you don't want to put 50% or whatever of your portfolio on that.

Starting point is 00:40:29 So how much should you put in if you want to manage your risk accordingly? me. It depends a little bit on how many positions you have in your portfolio, but let's say you're running 10 positions, 10 stock positions, each of which has 10% in the portfolio. If you find one that you think, look, this is a really, really cheap stock, the outcome, but for whatever reason, the balance sheet isn't ideal, or there's some risk in the stock. And you think this stock could go down 50%, this stock could go to zero, but there's a chance that this stock goes up 10 times, or it goes up two times or five times or whatever. So you think I don't want to put my money at risk there to 10% of the portfolio

Starting point is 00:41:07 because if it goes to zero, it'll blow up 10%. But I want to have that possibility of capturing that two, five, 10 times upside. So then I would go and look at the price of the calls, and I might put 1% of the portfolio value, which would be 10% premium relative to the position because 10% of 10% is 1%. So that way, if it goes to zero, I've only lost the 1% of the portfolio that I put into it. If it goes up two times or five times or 10 times, it's as if I've been long 10% of the stock. So my return can be that sort of size.

Starting point is 00:41:45 So that's the way I approach the calls. So typically I'm using them. I'm either using them because the volatility is very low and it's just a way to play that volatility as well. All right. So, Toby, the last question we have from you. This one comes from Brandon Saylor. So Brandon wrote to read the book, loved it. Can you have him walk through implementation of the screen,

Starting point is 00:42:06 when to buy, sell, and rebalance? It really depends on how much time you want to spend doing it. I write on the site there's two basic approaches to it. There's a quantitative approach, which just means you're going to buy everything in the screen without fear or favor, relying on the sort of statistical performance of value over time. or you can do this business owner approach, as we were talking about before you go through and

Starting point is 00:42:30 you actually do the valuations, putting aside the business owner approach, which is for people who really want to spend a lot of time doing it, the quant approach, you can buy the 30 positions once per year and revisit it a year minus one day, so 365 days later, you sell your losers, you sell the stocks that are down so that you capture all of the short term losses in this tax year and then you wait 366 days so that when you sell the winners you get long-term capital gains and ideally you sort of push the long-term capital gains into the next taxable year. You can do it more regularly than that. You could do it on a quarterly basis just checking in to sort of sell the loses and buy some

Starting point is 00:43:14 more winners that seems to work fine. That might give your own portfolio. It might make the returns a little bit closer to the sort of the value factors returns. but it's perfectly fine to only do it once a year because of the nature of value is that it takes undervalued stocks up to five years to sort of get back to valuation. So the vast bulk of the return comes out in the first year, but they still tend to be outperforming five years down the road. So I know in your screener at the Acquires Multiple, you have the large cap open for anybody to go there and use, but I'm curious, how do you find yourself investing? Do you find yourself typically

Starting point is 00:43:54 buying the large cap or mid-cap, small-cap, I'm just curious? Yeah, my portfolio is not so big that I'm forced into the large-caps. I tend to use the all-investable. That's the largest 50%, but the best returns have tended to come from the small-cap stocks. If you really like small-cap stocks, and you realize that small-cap stocks can be a little bit more difficult to invest in, they have wider bid-ask spreads. They tend to chop around a lot. There's a lot of volatility in the small-cap stocks.

Starting point is 00:44:21 If that doesn't worry you, if being down a lot on occasion doesn't worry you so much, then the small cap stocks, that was where I started out. I find them really fun to sort of go through. But just because I tend to be pretty busy in the business, I think that the all investable is the easiest to sort of implement. They're all fairly liquid and easy to trade, and you can get into them and out of them pretty easily. The smallest in there, I think, is a sort of $250 million market capitalization might be even a little bit bigger than that now. So they're liquid and they're easy to invest in. So for me, it's the all investable. Awesome.

Starting point is 00:44:56 All right, Toby, so thank you so much for coming back on the show. I know our audience always really looks forward to you coming back on and you're always sharing such insightful information. If people don't know who you are and they want to learn more about you, where can they find you? Thanks so much for having me, guys. It's always a great pleasure being on this show. The website is Acquireasmultable.com. The new book is called The Acquireers Multiple, and it's in Amazon.

Starting point is 00:45:19 You can get it in paperback or Kindle 999 on Kindle 1599 in the US. Or you can find me on Twitter at Greenback. It's a funny spelling, but it's G-R-E-E-N-B-A-C-K-D. And I'm on there sort of all day long, answering questions and posting stuff and liking and muting, doing all those things. It's really fun. So if you want to interact, I'm always there and ready to chat. Fantastic. Thank you, Toby, for coming on the show.

Starting point is 00:45:46 And I'm sure the audience excited to know that you will also be feeling. featured on the very next episode where you'll be pitching a stock to the mastermind group. But guys, that was all the press that I had for this week's episode of The Investors podcast. We'll see each other again next week. Thanks for listening to TIP. To access the show notes, courses or forums, go to theinvestorspodcast.com. To get your questions played on the show, go to asktheinvestors.com and win a free subscription to any of our courses on TIP Academy.

Starting point is 00:46:17 This show is for entertainment purposes only. Before making investment decisions, consult a professional. This show is copyrighted by the TIP network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP165: Tobias Carlisle and The Acquirer's Multiple (Investing Podcast)

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