Invert Investment
Acquirer's Multiple?
InvertInvestment
Publish date: Sun, 12 Aug 2018, 06:15 PM
In this post, I would like to share my experience experimenting in Bursa Malaysia after reading the book "Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations". The experiment ended up badly. However I want to highlight my mistakes here and hopefully I would not to commit another similar one again.
"Those who cannot remember the past are condemned to repeat it."
- Spanish-American philosopher George Santayana
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Back in Jan 2017, I read this wonderful book "Deep Value" by Tobias E. Carlisle. It talks about mean reversion and how Warren Buffett's investment philosophy has shifted from buying cigar-butt type of companies to wonderful companies. One compelling conclusion of this book is that you can easily beat the market with one formula, i.e. Acquirer's Multiple (hereafter called AM).
The book shows that in many of the major stock markets, e.g. US and Japan, if you rank all stocks by their AM from lowest to highest, you can beat the market by buying 10% of the stocks with lowest AM, hold them for one year, and then sell them, and redo the same thing for the next year. Record shows that this method beats the market by a huge margin.
For anyone who doesn't know what is AM, It's a way to measure how cheap a stock is. It consists of two components, EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) or EBIT (Earnings Before Interest, Taxes) and EV (Enterprise Value). And AM = (EV / EBIDTA).
You can just think of it as PE (Price-Earning ratio) on steroids, while PE doesn't capture the debt of company, minority stake and other stuff, AM encapsulates all of them.
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After reading this book, I was so thrilled and eager to try this quantitative method. But how does one find stocks with lowest AM in Bursa Malaysia? I didn't know of any good ways back then, and even now.
I did however find one website with reasonable amount of free good data, i.e. isaham.my, which has AM calculated for each stocks. Fearing of missing out opportunities, I quickly did some filterings and searches and came up with four stocks with very low AM (I also did my calculations to ensure the AMs are indeed low enough! If I recall correctly, their AM range from 2.5 to 4.5). I then allocated about RM 8,000 for this experiment in Feb 2017 and I bought approximately RM 2,000 worth of each stock with the price below:
1. Harbour (0.8)
2. Flbhd (1.69)
3. Kfima (1.8)
4. Favco (2.7)
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Fast forward one year, did I make any gains? No. Did I make any loss? Hell yes. In fact I am pretty sure I was underwater 95%+ of the time. The current market prices for the stocks are:
1. Harbour (0.74) -0.06
2. Flbhd (1.26) -0.43
3. Kfima (1.71) -0.09
4. Favco (2.65) -0.05
The portfolio's loss to date is about 10% while our index KLCI has soared roughly 11% from 1620 to 1800. That being said, my net loss is 21%!
(The loss is theorectical because I've sold two of the above stocks at lower prices few months ago since the one year mark has passed. And for the other two, I've decided to keep them.)
But my point is why such a proven method doesn't work for me? What did I do wrong? After much thoughts and reflections, I have concluded the following as my mistakes:
1. The sample size is way too small, only four stocks! Comparing to the tens or hundreads of stocks in the book's experiments, four stocks is not representative. So even if what I was doing was correct, I could be so unlucky to get all the loser stocks. When sample size is small, I get all sort of variability.
2. How did I know the four stocks I picked were having lowest AM? I couldn't tell because didn't have complete data!
3. There's no backtesting done on Bursa Malaysia with this method, how did I know it will work?
Having said that, with insufficient fund, I should've realised I can't replicate completely the book's method and it was so easy to spot my blindspots in hindsight, but I was too excited then to give a try as soon as possible.
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Going forward, I want to warn myself to keep things realistic and do only things which I know what I am doing. Don't blindly invest just because I've read some books or videos and thought myself has been equipped with some magical knowledge and wanted to put them to use immediately. Hasty decisions are often poor decisions. Furthermore, there's no such thing as sure win, otherwise these books wouldn't be published in the first place! right?
Lastly, I hope you too learned something from this post. Cheers.
If you spot any mistake or have any disagreement, please comment below. Also if you happen to know of any website which has quality Bursa data, please share, thanks!
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"The Most Important Thing" by Billionaire Howard Marks - part 2
Created by InvertInvestment | Sep 08, 2018
Discussions
2 people like this. Showing 16 of 16 comments
AM is not the only indicator. It has to come with some other indicator like roic, quick ratio, dy, free cash flow. And don’t forget the target price. If you can’t even give a target price then how you know what kind of upside potential you are getting into.
How to calculate target price is based on your ability to use dcf, absolute pe etc and you have to find one that suit you based on your years of experience. Put your self like a biz men, if you want to buy something and sell it later what you need to do?
Besides if the stock continue to give good dividend and the biz is still relevant then you should buy more when the price came down else you should have cut lost earlier. To do so, you have to really study the qualitative part not only quantitative from annual report, quarterly report and any report relevant to the company to know the future of the company biz.
Last but not least if it is so simple just based on one indicator to invest, think everyone become very rich now. So always ask yourself is it too good to be true.
2018-08-12 19:28
eat and wear how much is fated.
same method same strategy at different times yield different results.
2018-08-12 19:29
one more thing.....tests are not falsifiable unless the start and end dates are clearly defined.
2018-08-12 19:31
Jeff is right..
You need to select a sector with high potential growth before you apply your AM or other key ratio in stock selection.
IMO DFC only works if the counter command large scale of market share or holding monopoly rights.
Always cutloss if qtr report sales or sector in declining trend.
2018-08-12 19:47
Forget about ev/ebitda or other fancy ratio. Keep it simply...u want earning play stick to simply earning play which uncle koon already mention many time, eps !!.
2018-08-12 20:46
>VenFx
I would like to know how that would turn out to be. Unfortunately I don't tool to do that kind of backtesting
>Jeffbkt
I agree there are numerous ratios we could and should use to make an investment decision, and we should always set a target price before putting in money (otherwise how would we know it's underpriced right?).
But for the sake of this quantitative approach, it's buying 10% of all the stocks (in S&P 500 or Rusell 2000 or whatever you name it) with the lowest AM, hold them for one year, and then sell them, and redo the same thing (find stocks with the lowest AM again) for the next year.
Cheers
2018-08-12 23:35
>qqq3
The experiment is done with one year period, hence start date and end date are defined right at the beginning. And regarding your comment "stock market got phases...at each phase , best strategy is different.", I sense something cyclical? :)
2018-08-12 23:37
Posted by InvertInvestment > Aug 12, 2018 11:35 PM | Report Abuse
>VenFx
I would like to know how that would turn out to be. Unfortunately I don't tool to do that kind of backtesting
ME : I just share my view, as myself also find troublesome to do such back testing. But, i always start from sector screening and trying very best to dig the future explode - able out ...
2018-08-12 23:41
I tell u what.....with Trump wars and Malaysia is belt tightening mode.....I will not be value investor if I am you....
I shall become trader, hit and run and curi curi makan.
2018-08-12 23:49
1. As you mentioned, your portfolio is too small. Probably need at least 30-40 stocks. Deep value relies on a small amount of stocks in the portfolio to cover the losses for most of the stocks. It rely on magnitude of gain over frequency of losses.
2. The reason why it works is because it doesn't work all the time. Similar to Joel Greenblatt's strategy.
2018-08-13 07:35
>Ricky Yeo
"Deep value relies on a small amount of stocks in the portfolio to cover the losses for most of the stocks"
Thanks for comment, would like to know more about this, e.g. where can I get more information about this?
"The reason why it works is because it doesn't work all the time."
Food for thought, erm...
2018-08-13 20:52
i dont see anything wrong with your strategy of selecting stocks based on low EV/EBIDTA
perhaps you should give yourself more time, say 3-4 years instead of 1 year span for you to conclude the investment outcome. 1 year is too short.
2018-08-14 14:08
i have both flbhd and favco. both stocks are cheap enough with limited downside risk.
2018-08-14 14:10
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VenFx
At least the above selected has their own edges as a small penny.
Should try with different cap eg. < $300m ; > 1000m ; and 5000m .
2018-08-12 18:34