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Transcript

00:02

CHRIS COLE: Hello, everyone.

00:03

My name is Christopher Cole.

00:04

I’m here with Real Vision today in our offices of Artemis Capital, and it is my pleasure

00:08

and honor to be interviewing an old friend of mine, Toby Carlisle, who is the founder

00:14

and principal of the Acquirer’s Funds.

00:18

Toby is an expert on value investing, and has written four books on the topic, which

00:24

are really new classics in the field, and should be read by any serious value investor.

00:30

I’d like to introduce Real Vision to Toby Carlisle.

00:32

TOBIAS CARLISLE: Thanks for the very kind introduction, Chris.

00:34

I’m very happy to be here.

00:36

I’m so happy to be doing it with you.

00:37

CHRIS COLE: Well, Toby, tell us about how did you get into value investing.

00:41

TOBIAS CARLISLE: I was a mergers and acquisitions lawyer in Australia initially and then in

00:46

San Francisco, went back to Australia to be a general counsel of a public company that

00:53

was a telecommunications company.

00:57

I started working 2000 right at the very top of the dot-com boom, saw the collapse, and

01:03

then saw the emergence of this new breed of investors that new to me.

01:09

Nobody had really heard from these guys since the ’80s, but they were the guys who’ve been

01:15

doing the takeovers in the ’80s had returned.

01:18

They weren’t known as activists at that stage.

01:21

We didn’t really have a name for them.

01:22

They’re looking to get control of these busted dot-com businesses that had raised a whole

01:27

lot of cash, had an enormous amount of cash burn.

01:30

It was hard to figure out what they saw in these businesses, because I had read security

01:35

analysis, the Graham and Dodd book, and I’d read Warren Buffett’s letters, and he talks

01:41

about looking for a wonderful company at a fair price.

01:44

These weren’t wonderful companies at all.

01:45

They’re terrible companies, terrible businesses, but because they had raised so much cash,

01:49

they traded down the discount to their cash, these guys were looking to get control, looking

01:53

to get control of the cash then to either liquidate the company or use it to buy other

02:00

companies.

02:02

That period from early 2003 to about 2007 was a golden age for value.

02:09

Deep value guys coming through activists, private equity firms taking company.

02:14

I just thought if that ever happens again that the market gets cheap enough that that

02:19

strategy of buying sub-liquidation value companies, if that opportunity presents itself again,

02:24

I’ll take advantage of that and try and buy those companies.

02:28

When the 2007-2009 collapse occurred, I stopped working as a lawyer, set up a little fund,

02:36

set up a blog talking about buying the subliquidation value companies.

02:40

I just fell in love with the strategy and the process.

02:44

I continue to research, write some books and that’s how I get to here.

02:48

CHRIS COLE: I think one of the most interesting things about your research is that you have,

02:54

there’s so many individuals that follow the value investing framework, and I think everyone’s

02:59

knowledgeable with a canon of material out there, securities analysis, Benjamin Graham,

03:04

but you’ve added some new twist to that through quantitative research, and I wanted you to

03:09

talk about that and how that plays into the concept of the Acquirer’s Fund?

03:14

TOBIAS CARLISLE: Well, I think rather than adding too much of a new twist, what we’ve

03:18

done is just revived some of the old ideas.

03:22

Because Warren Buffett has been so successful, and he’s the avatar of value, and he preaches

03:28

this wonderful company at a fair price philosophy.

03:32

Many of today’s value investors have similarly embraced that philosophy and so they look

03:37

for particular things, high returns on invested capital, moats, compounding type businesses

03:42

that grow very rapidly.

03:44

Then they’re trying to buy at a fair price which might be saying a market multiple for

03:49

a company that is better than that.

03:51

That’s one very small part of value investing.

03:54

There’s a much broader universe out there.

03:56

The idea is simply that you’re buying something for less than it’s worth.

04:02

Typically that’s hard to do, because most companies don’t really trade at a big discount

04:06

to what they’re worth.

04:07

The places where you find those big discounts is in financial distress where an industry

04:15

might be going through a down cycle.

04:18

That is what I described as deep value, where what we’re trying to do is we might be trying

04:22

to buy at a discount to balance sheet value, we might be trying to buy a cyclical company

04:26

at the bottom of its cycle, and then trying to buy at a further discount to that.

04:30

Then we’re hoping that there’s an uplift in the way that the business performs and then

04:35

you will still get the discount between the intrinsic value and the price at closing.

04:39

You have two ways to make money.

04:42

We did some research, I did some research with [indiscernible] PhD at but haven’t found

04:47

every bit of industry and academic research that we could find that had been published

04:51

from Graham onwards, from the 30s onwards, and we tested that in a system to see what

04:57

works, what continues to work, what stopped working, what never worked.

05:02

There are many things that were perhaps a product of data mining.

05:06

We looked at how do you identify a good credit?

05:10

How do you find something that’s financially strong?

05:13

How do you Identify earnings manipulation?

05:15

How do you find statistical fraud?

05:17

How do you find businesses that are very cheap and can grow and buy back stock and the product

05:24

of that research was a book called Quantitative Value.

05:27

I noticed this unusual phenomenon while we were doing it, that very undervalued companies

05:31

behave in an unusual way that sometimes the things that the less attractive the business,

05:39

the better the performance of the stock, because they just get too cheap and so nobody in their

05:45

right mind would go and buy these things unless you can find some of these other indicia of

05:49

value or quality in there.

05:52

That was a book called Deep Value that came out 2014 discussing the mechanics of mean

05:57

reversion.

05:59

Those mechanics are simply they’re private equity funds, there are activists who will

06:03

come in and turn these companies around.

06:05

There’s also management in there, not liking the performance of the company.

06:09

They might be beholden to the industry cycle and as other participants in the industry

06:17

leave, the ones that remain can ask for higher prices for their services or for their goods

06:23

and so they then get a period of very good performance.

06:25

I just found that a fascinating approach and it’s not one that is discussed much outside

06:32

of Buffett.

06:34

Buffett’s wonderful companies at fair price.

06:37

My research is focused more on those type of businesses and that’s what the fund does.

06:42

The fund to buy– we like balance sheet strength is great, and we can find it so we will have

06:49

a strong healthy balance sheet, lots of cashflow coming into the business as well, lots of

06:53

free cash flow.

06:55

This is on the long side because we did run long/short.

06:57

We like the company to be buying back stock.

07:00

I think that’s a very powerful signal which shows that there is that free cashflow there,

07:04

it’s genuine free cash flow, management’s thinking like you would want management to

07:10

think taking advantage of that undervalued stock price.

07:13

I think when you see a material buyback, that also indicates that the stock is undervalued

07:17

because you see lots of buybacks through the cycle, buybacks tend to peak at the top of

07:21

the cycle.

07:22

There might be mopping up option issuance or just trying to goose the stock price at

07:26

the very top of the cycle.

07:28

That’s not the buyback that you want.

07:29

You want material buybacks.

07:31

Those things together on the long side, that’s a pretty traditional– we’re going to find,

07:37

we will own cyclical companies, we’ll buy companies that it might be difficult to understand

07:43

the reasons why we’re buying them because it might look like the business is in a particularly

07:47

good one, that we think that the combination of balance sheet strength at the bottom of

07:51

the cycle, it’ll look like a healthier business going forward.

07:54

On the short side, we’re looking for somewhat of the reverse of that, something that’s extremely

08:00

overvalued to the extent that you can identify a value to some of these companies.

08:03

It’s very hard, there may not be any value there at all, but more importantly, they’re

08:10

in financial distress.

08:11

There’s some statistical earnings manipulations, statistical fraud, they have negative free

08:16

cashflows so the way they’re financing the businesses by raising equity or selling debt.

08:24

That’s a game that can go on until it stops, until the market no longer lets you do that.

08:31

We also look for broken momentum because many of these companies will finance themselves

08:35

by telling a great story, even though the financial statements don’t reflect the narrative.

08:42

The narrative is wildly diverged from the financial reality of the company.

08:47

That’s what we like to find on the short side, really compelling narrative but none of that

08:52

is being reflected in the financial statements.

08:55

When the market starts seeing that too, and that momentum has gone from– or the momentum

09:00

is broken, we’ll take a short position.

09:03

In the ordinary course, we hope to make a little bit of money on the short side, but

09:07

the real function of the short so when the market collapses, they should provide more

09:11

protection than their weight in the portfolio.

09:15

You hope through a 2000 or 2007 and 2009 type scenario that it would perhaps prevent you

09:21

from drawing down as much as the market.

09:23

CHRIS COLE: You found that there are certain quantitative metrics that are highly indicative

09:29

of a quality value play.

09:32

Maybe to talk a little bit about that, and how that differs from some of the other viewpoints

09:39

out there on that.

09:40

TOBIAS CARLISLE: It’s become much more popular, it’s voguish now to largely to ignore balance

09:48

sheet quality.

09:50

For a company to grow very rapidly, it helps it for it to be asset wide and they might

09:56

run with very substantial amount of debt on the balance sheet which when they’re running

10:01

up, that means they run very fast, and they’ll go year after year, performing very well.

10:08

The problem is that it doesn’t allay so much in the way of– there’s very little balance

10:13

when you go the other way.

10:14

What I like is balance sheet strength.

10:17

To the extent that we’re using these statistical measures, it’s not necessarily a new invention.

10:22

I don’t regard it necessarily as, it’s not like a NASA level analysis of the companies.

10:26

It’s just we’re trying to find a– it’s a sensible approach of doing it.

10:30

The reason we do it that way rather than trying to be more discretionary and more ad hoc in

10:35

our approaches that we think that there are good behavior reasons, and there’s lots of

10:41

research that indicates that a more systematic, disciplined, quantitative, replicable approach

10:48

to doing it means that through the bad times, you’re able to keep on functioning and doing

10:55

what you should be doing, buying the right stuff, you don’t swing for the fences, keep

10:58

sizes of positions fairly small, consistently apply the approach, because every strategy

11:04

has good times and bad times and value has gone through a very rough time.

11:09

Since the start of the year, if you track the factors that have done well, it’s the

11:15

factors that have done well for the last few years, momentum is done very well, growth

11:18

has done very well.

11:20

Value has done very badly.

11:22

Quality has done very badly, which is historical.

11:25

Typically, what happens is there’s a value premium, you get a little bit more performance

11:30

for buying these companies that are trading at a discount to intrinsic value, and that’s

11:35

not been the case.

11:36

CHRIS COLE: Let’s talk about that a little bit.

11:37

It’s really, really interesting, because, I’m a volatility guy.

11:41

You’re a value guy.

11:44

Years ago, we bonded back in Santa Monica, two completely different disciplines but we

11:51

share some things in common in the sense that value can perform during periods of market

11:56

crisis.

11:57

I’m curious for you to talk a little bit about the history of value over the last 20, 30

12:05

years, how it performs in different market cycles, its defensive properties, and to answer

12:10

this question, value has underperformed for 10 years, is value investing dead?

12:16

Is it dead?

12:19

To get your take on that, not that I believe that, but.

12:22

TOBIAS CARLISLE: That’s a question I get a lot.

12:24

Is value dead?

12:25

Can value come again?

12:27

I don’t know but I can go back to that– we have pretty good data on value back to 1951,

12:36

point in time data to 1973.

12:39

There are very distinct cycles through that entire period.

12:45

Over the full period, the outperformance for just a simple price to a fundamental whether

12:51

it be price to book or price to cashflow, enterprise value of cashflow, enterprise value

12:55

to EBITDA, even price to earnings, very simple metrics.

12:59

The outperformance to the low price to a fundamental which is a reasonable proxy for a value stock

13:06

has been massive.

13:09

The growth side of that equation where you’re paying a higher price for that fundamental

13:14

has been pretty weak.

13:15

Behaviorally, you might say, well, why would you pay that higher price?

13:19

Because the very best performers have always been expensive.

13:23

Walmart, for most of the time it was listed was always very expensive.

13:28

Microsoft’s mostly always been pretty expensive.

13:31

The companies that you buy that have these low prices to a fundamental tend to be junkier

13:36

companies, cyclical companies, but you get paid to hold those companies.

13:43

You don’t get paid all the time.

13:44

You get paid over the full data series and the full cycle as well because value performs

13:50

various different ways through the cycle.

13:53

From the bottom of a crash, value does spectacularly well, value should provide some protection

13:58

through a crash.

At the tail end of a bull market, value looks terrible because the bid from value guys goes  away.

14:05

The people who are feelers and who are prepared to pay increasingly higher prices will do

14:10

very well through that tail end, but then there is some justice for those guys.

14:13

There’s a typically very significant crash to the momentum growth side through the cycle.

14:19

There have been about six periods where value has underperformed materially.

They’re all were very well known bull peaks.

The last one was 2000, in the run up to the dot-com, value performed very badly.

They’re all the covers has Warren Buffett lost his magic.

14:37

CHRIS COLE: The barons won.

14:39

TOBIAS CARLISLE: Then value did then go on to perform pretty well for that for the early

14:45

2000s.

14:46

Then it’s been week again, so it depends on how you measure value.

14:50

Price to book value, that’s the value factor.

That’s the academic definition of value.

No practitioner uses price to book value, but that’s the one that everybody points to,

because that’s the one that the academics prefer, because it’s very simple to calculate

15:02

and there are some good reasons, it’s less volatile, the fundamental is less volatile

15:06

where earnings is moving around, book value is reasonably static from quarter to quarter.

15:11

It’s a reasonable proxy.

15:13

It really hasn’t outperformed for 14 or 15 years.

15:18

There are many reasons for that.

15:20

Partially, it’s the composition of balance sheets has changed over time.

15:25

There are companies out there that have bought back so much stock that actually got a negative

book value.

15:32

It’s very difficult for book value to categorize them as a value stock, even though if we wouldlook at them on another measure, like a price to earnings, we would regard them as value

stocks.

15:43

Book value hasn’t worked, but there’s no practitioner who actually uses it.

15:46

If you use an ensemble of measures that might be cash flow and earnings, and sales, even,

15:53

that would have helped you keep up for the market for longer but it’s still failed sometime

15:57

over the last five years.

15:59

If you have some craftsmanship, which is what the more quantitative value guys describe

16:04

as their own mix that they use, where you might look at other things besides simple

16:12

values, you might look at the quality of the balance sheet, the quality of the earnings,

do the cashflows match the reported earnings, because that’s important.

You can have wild deviations where companies are reporting good earnings, but it’s not

reflected in cash flow generation.

16:28

If you use all of those measures, which is what most practitioners are doing, that kept

up with the market, and that outperformed pretty well until about the start of 2018.

Since 2018, that hasn’t worked very well.

16:42

That’s a shorter period of time.

16:43

That’s probably what most practitioners have seen.

16:46

It’s been a period of weakness for value.

16:50

There are pockets like that through the data series where that happens and then immediately

16:55

afterwards, there is some very good performance for value.

16:57

The thing that would make me nervous is if value was underperforming but the portfolios

17:05

as they reformed at each rebalance that aren’t reflecting the discount that we’re seeing,

17:10

but what has been happening is the value portfolios have been getting cheaper so that the price

17:16

ratios are wider.

17:18

What has happened now is that the most overvalued stocks are extremely overvalued, more overvalued

than perhaps may have been ever.

The undervalued stocks, maybe at their long run mean, maybe a little bit rich to the long

17:32

run mean.

17:33

I think at some stage, we don’t necessarily have to have a crash, the cycle can just go

17:40

back to value, but most likely what happens is that there’s some crash that resets the

17:45

market.

17:46

In the crash, what has happened when momentum and growth have run like this is that the

downdraft has been massive for them.

It’s been to the tune of 80% or 90%.

17:58

I think value could pull back a little bit.

18:00

I think that you want to be long short as a value guy going into the next crash to really

18:06

see the performance and maybe capture some outperformance on the way down and then to

18:12

be fully invested when the market finally does not turn and I think it will be a very

good period for value from the bottom.

18:17

CHRIS COLE: This is a powerful idea that in a late cycle, if we’re entering into some

18:22

late cycle secular change or some recession, value will drop like momentum stocks, but

18:31

will drop less in a market correction and that a long/short, something that is short

18:38

the momentum stocks, the hot stocks, the highflyers that are making money and long the inexpensive

18:45

value stocks, that long/short positioning will outperform and deliver alpha.

18:52

It’s interesting too, because even if you’re just a macro guy and you don’t pick stocks,

18:58

I’m a volatility trigger so I don’t pick any individual stocks, but I paid very close attention

19:04

to the value momentum relationship.

19:07

Any good macro investor should because it is an interesting forward indicator to volatility.

19:13

I think it’s very interesting that this last October, we saw one of the most violent reversals,

19:22

at least when I was looking at the data, it was multiple days, there’s one day I think

19:26

was a six standard deviation move and other day, there was a three standard deviation

19:29

move.

19:31

Truly wild moves where value dramatically rebounded against momentum stocks.

Can you talk about how good that is as a signal to the macro investor community?

19:43

Is that something that we should pay attention to?

19:46

What’s your take on that recent reversal that has occurred over the last couple months?

19:52

TOBIAS CARLISLE: The thing that you’re describing, the spread got very, very wide, as wide as

19:58

it has ever been through August 27th was the bottom of that spread and then it did start

20:04

closing fractionally from August 27th through to September 9 th, which was then the biggest

20:10

one-day move in value’s favor since the early 2000s, sometime in the early 2000s, that’s

20:16

the five or six sigma move that you’re referring to which any quant note will tell you that

20:23

it’s not a normal distribution.

20:27

The point remains that it’s still was a very big move in value’s favor and it was a very

20:32

bad day for momentum.

20:33

Then it was followed up the next day by that three sigma move in value’s favor, and away

20:38

from momentum.

20:39

Then it was a very good September, October, November, December for value.

20:44

Value outperformed the market through all of those months.

20:46

It’s softened up through January, it wasn’t a great January, it wasn’t a great January

20:51

for value, was a very good January for momentum, one of the best months for momentum in 20

20:58

years or something like that.

21:00

It’s good to see those guys win once in a while.

21:03

I think that that’s what you would expect to see when there’s a regime change, very

21:07

high volatility in the turn, because I think that that’s the way regimes change.

21:12

You get that move and that frightens folks who are in the momentum strategy.

21:16

They realize there is some downside to that strategy, because they haven’t seen a lot

21:19

of it.

21:21

I see that particularly in low volatility strategies.

21:24

Low volatility wasn’t something that I think folks had heard much about until a few years

21:29

ago, two or three years ago.

21:31

I think it became very voguish a few years ago, and the reason why is pretty clear, when

21:36

you look at the data, low volatility strategies typically do what they say they do.

21:41

They don’t go up as much as the market does when it goes up, but they don’t get down as

21:44

much as the market does when it goes down.

21:47

Over the last five years, that’s not been the case.

21:49

It’s materially outperformed.

21:50

CHRIS COLE: The low volatility, just for the viewers, low volatility described strategies

21:55

that effectively are hurting into stocks that are low vol stocks, low beta stocks, in essence

22:02

trying to use stocks as a replacement for maybe bonds.

22:05

TOBIAS CARLISLE: I think that’s right.

22:06

Well, there’s the joke doing the rounds now that you buy bonds for the growth and you

22:15

buy equities for the yield, whereas that’s not traditionally been the case.

22:19

Low volatility is beneficiary of that, particularly because for that reason that you identified,

22:24

I think that it regarded potentially as a bond replacement to the extent that equities

22:29

further down the capital structure can do that.

22:31

I’ve looked at low volatility in relation to value, I just ran this progression over

22:36

the weekend because I was interested to see what does it look like?

22:40

The notable times when low volatility has outperformed value, much 2009 was the peak

22:46

for low volatility relative to value in the last say, decade or so.

22:52

Reasons for that are very easy to understand.

22:54

That was the bottom of the crash and we performed very well at the other side of that.

23:01

Then June 2, 2012, there was a little echo crash around that period of time.

23:08

I don’t know if folks remember that but it looked like we might be going back into another

23:13

crash, and I think that that’s when some of the QEs started again.

23:17

CHRIS COLE: In 2012?

23:18

TOBIAS CARLISLE: 2012.

23:19

CHRIS COLE: It looked like we began to see outperformance of value during that period

23:24

of time and then they put on QE, they did QE3 at that point.

23:31

TOBIAS CARLISLE: In 2013, the market had a very, very good year.

23:34

I remember discussing it with you at the time because it was a very good return for the

23:37

market but also a very low volatility year.

23:40

It was one of the best risk adjusted returns on record, 2013.

23:44

Now, been replaced by some of the more recent years, but at the time, that was a significant

23:48

move.

23:49

CHRIS COLE: I’ll even say one of the best risk adjusted years and one of the best risk

23:53

adjusted three-year period starting that year in 200 years’ worth of equity data for passive

23:58

investing over that period of time, truly amazing.

24:00

TOBIAS CARLISLE: That was a good year, 2013 was a good year for the market.

24:03

It was about a 50% year for the market, but it was a 60% year for value, so very good

24:08

year for value, too.

24:10

It was really the last time that value did anything material.

24:14

Value’s had– 2016 was a good year for value, but 2015 was a very weak year for value and

24:19

then ’17, ’18, and ’19 have been disasters for value guys.

24:26

When I look at the data now, there’s a very significant peak in the outperformance of

24:31

low volatility strategies over value strategies.

24:34

What that has typically indicated in the past is that we’re about to have a very good period

24:39

for value in the near term, and a weaker period for some of those strategies.

24:44

Volatility will almost certainly be a beneficiary of that, too.

24:47

CHRIS COLE: That’s interesting.

24:48

Also maybe that a lot of these institutions that are crowding into low vol stocks, maybe

24:55

that low vol stock might underperform value based– and might underperform people’s expectations

25:00

based on some of your analysis in that department.

25:02

TOBIAS CARLISLE: Well, that would be my expectation that value will materially outperform and

25:05

low volatility will have a more difficult period.

25:08

I would say that if you look at low volatility, they tend to be extremely expensive stocks

25:12

at the moment, and the rebuttal to that is always that low volatility is not a strategy

25:17

that depends on those stocks being cheap.

25:21

We’ve been through this very unusual period for this performance of volatility, low volatility,

25:26

and so I think that there’s been quite a lot of crowding into low volatility strategies,

25:30

either consciously or unconsciously.

25:33

I think it’s some of these stocks that have those very smooth returns do attract folks

25:37

who perhaps are looking more at the price trajectory than the fundamentals of the business.

25:42

You can see that, you can pull up any chart, pull up the Microsoft chart has that fit like

25:48

the ski jump path to it, Apple’s chart has the same ski jump up to it.

25:54

Tesla’s chart, after doing nothing for years and years has had that fivefold increase in

26:00

the last six months.

26:02

Who knows what the cause of that is?

26:03

There are lots of theories about it at the moment, maybe there are more shorts out there

26:09

than we know about.

26:10

It’s one possibility.

26:12

This delta hedging in the– now that there’s a lot of action in the options, maybe the

26:17

delta hedging into the equity that keeps on pushing it up.

26:19

The Tesla, I think is a very good example.

26:21

It’s a weaker balance sheet, financial statements aren’t great for Tesla.

26:28

There’s no growth but its 2% year on year revenue growth, they’re selling more cars,

26:33

but they’re not selling them.

26:34

They’re not making as much money as they have in the past.

26:36

It’s a metal bender, it still has to create a factory to make these cars.

26:41

It’s not like software as a service where each marginal sales virtually costs and yet

26:46

it moves like a software as a service stock.

26:48

CHRIS COLE: To this point, this is interesting.

26:49

It goes back to something you and I were talking about maybe a couple weeks ago, where I think

26:54

I was telling you the story of how I was in Switzerland.

26:57

We were going to a meeting, leaving Zurich to go to [indiscernible].

27:03

My marketing guy is like, well, let’s take an Uber.

27:08

I’m like, no, it’s going to be really expensive.

27:10

Let’s take the train.

27:11

Switzerland has one of the best train systems in the world.

27:14

He said, no, the Uber is cheaper.

27:16

I’m like, that’s impossible.

27:18

How is Uber cheaper than taking a train in Switzerland?

27:21

It was.

27:22

This is to go an hour and a half outside of Zurich.

27:25

The only rationale I have on that is that you have– I actually wanted to thank SoftBank

27:31

for subsidizing my business trip but, effectively, what’s your take on this where you have–

27:37

they always say, never go into business with a non-economic actor.

27:41

That’s probably why you and I don’t own nightclubs.

27:44

In this mindset, if you have cheap money from central banks, they’ve lowered interest rates

27:49

down to zero and the big institutions of the world are throwing money at VC funds that

27:56

are throwing money into these companies and they don’t care if they ever make a profit.

28:01

They’re just looking for growth, in a frenzy for growth.

28:07

There’s no assessment of value, then other brick and mortar companies that are seeking

28:13

return of profit and have to pay people and are actually looking to a long term survival

28:20

have to compete against these new disruptive technologies, that are actually being subsidized

28:25

by inexpensive money.

28:27

To what point are central banks crowding out value investors?

28:30

TOBIAS CARLISLE: That’s a great question.

28:32

I think it’s been a great time for consumers.

28:35

There’s been enormous consumer surplus subsidized by the VCs on Sand Hill Road.

28:40

That’s been great for everybody to get cheaper taxi rides, among other things.

28:47

What drives that?

28:50

Potentially that’s too low interest rates making marginal business ventures look better

28:55

than they would otherwise look.

28:56

If your cost of money is virtually zero, then you can get a return anywhere that will be

29:01

better than virtually zero cost of money, then that’s a project that you should probably

29:05

be investing in.

29:06

That’s one of the problems that interest rates being set to flooding the market with money

29:12

creates that better businesses aren’t rewarded for being better businesses.

29:18

Being a careful husband of the cash on your balance sheet, that’s not rewarded at all.

29:25

Spending it to grow is rewarded.

29:28

The way that that is reflected is in that duration trade where the 30-year, when interest

29:36

rates move, the 30-year moves a lot more than the 10-year.

29:39

The 10-year is more like a value stock or value stocks are shorter duration, because

29:44

their cash flow as a front end load.

29:47

You buy cheap cash flows now, perhaps expecting that there’s not going to be as much growth

29:51

or there might be a little decline in the cashflows of the value stocks.

29:55

Whereas the growth stocks, they’re not earning any cashflows now, all of the cashflow was

29:59

back end loaded to the extent that they can’t make any cash for it at all, but that’s the

30:03

expectation.

30:04

When you move interest rates a little bit, you get wild moves from the growth stocks,

30:08

you drop interest rates, you get wild moves up from the growth stocks, value stocks don’t

30:12

tend to be sensitive.

30:14

Maybe interest rates need to go up for value to start working.

30:16

I’ve heard that argument.

30:17

I think that’s a very good argument.

30:19

The problem is that I think there are lots of really good arguments for why value hasn’t

30:22

worked and some of them are going to be right in retrospect, and some are going to be wrong.

30:27

I think, ultimately, as a value investor, you can overcomplicate things by trying to

30:32

figure out the macro driving those side effects or those phenomena.

30:40

I think that you can simplify, as a value investor, you can simplify it for yourself

30:45

by just working out if the individual company that you’re looking at is in fact, undervalued.

30:50

Then looking at, to your point, are there non-economic, are there irrational actors

30:55

who they’re competing with.

30:58

Sometimes that’s a good thing.

30:59

That’s what creates the undervaluation.

31:01

Then can that non-rational, non-economic actor survive, or will they be washed away eventually?

31:08

I think that that’s some of what we’ve seen over the last five years that there’s been

31:12

an expectation that at some stage, that flood of money in will– that spigot will get turned

31:18

off at some stage and so you’ll be rewarded for doing the analysis, looking at the balance

31:24

sheet, looking at the strength of the business, the quality of the cashflows that it’s generating,

31:29

but not yet.

31:30

CHRIS COLE: It has a similar dynamic to I would say volatility where you can suppress

31:36

volatility, but the more you suppress it– you can suppress it for a long time, but the

31:41

more you suppress it, the more it will realize itself in other ways and eventually come out

31:46

even greater than before.

31:47

TOBIAS CARLISLE: Well, you have the great analogy of burning back that the tinder in

31:52

the tall trees in the forest.

31:56

If you don’t burn it back, that creates these explosive wildfires.

32:00

I think that’s true also, that little bit of interest rate volatility or a little bit

32:05

of higher rates strengthens these companies.

32:09

It makes them better companies, better businesses, better managements.

32:14

When they get fat and happy because the tinder’s not being burnt back on a regular basis, that’s

32:20

when they set themselves up for a big crash at some stage.

32:23

CHRIS COLE: Same concept that the longer the period of value underperformance in essence,

32:27

the greater the value proposition becomes on the other end of it for those who are patient.

32:32

TOBIAS CARLISLE: Or those who can survive, too.

32:34

CHRIS COLE: The business risk.

32:35

TOBIAS CARLISLE: Because this is the problem with it.

32:37

Value has become a little bit of a laughingstock, there aren’t very many traditional value guys

32:41

around because it’s so hard to maintain, it’s hard to keep investors when you can get, for

32:48

basis points, you can get access to the index, and the index is the best performing asset

32:53

in the world, but that makes any other active look pretty ugly, and particularly when any

32:58

other active wants to charge a slightly higher fee.

33:01

Again, that’s historical, it’s not something that these trees don’t grow to the sky at

33:08

some stage, there is that reckoning.

33:10

I fully expect it to happen at some stage, I’m not predicting one in the short term or

33:15

in the medium term, I’m not predicting one at all at the market.

33:18

I think if I’ve learned anything over the last decade or so, it’s that the market is

33:25

unpredictable and humbling at every stage.

33:27

You never want to make a prediction about the future.

33:30

I would prefer to be, at this stage, in something like a value strategy than in the index or

33:35

in low volatility or momentum, because I think that value was really the only thing that

33:39

can provide returns over the next decade that are absolute or relatively better than anything

33:48

else out there.

33:49

I think everything else is going to have a very tough run over the next decade.

33:52

CHRIS COLE: It was almost a decade ago, I remember, when someone asked this.

33:55

There was a young kid who wanted to go on Wall Street and somebody asked us to give

33:59

him advice or something.

34:00

We took about breaks.

34:01

I remember we sat down and this poor kid, we were like, you need to go find the sector

34:07

that is the most depressed sector imaginable.

34:11

Get into that sector.

34:12

Everyone will hate it, and by the time you’re vice president, you’ll be the only person

34:16

who knows anything about it and the sector will be doing really well.

34:19

TOBIAS CARLISLE: That’s great advice.

34:20

CHRIS COLE: It’s great.

34:21

Now, you can’t find any more too depressed sectors than value investing or disciplines

34:30

than value investing and volatility, long volatility trading.

34:33

TOBIAS CARLISLE: Well, I think one of the things about value is that value is that moveable

34:36

phase, value’s always going to where the disaster is, or where nothing’s happened for a long

34:41

time.

34:42

Value, at the moment, looks like it’s pretty heavily into financials and energy, and miners

34:48

and heavy industry, which haven’t done much for a long period of time.

34:52

We have a lot of financials, and we’ve got some energy exposure, too.

34:56

Part of the underperformance of value has been that sector mismatch or the industry

35:00

mismatch.

35:02

If you’ve been a value investor in technology, you would have outperformed any naive market

35:09

capitalization, weighted implementation of that.

35:12

The problem if you’re investing across every sector, every industry is that you’re more

35:18

heavily weighted towards financials and other things that haven’t done as well.

35:22

The financials that– the reason for the underperformance probably, interest rates are probably hurting

35:29

financials, and the memories of 2007 to 2009 is still very vivid in anybody who lived through

35:36

that period, and so they’re wary, and rightly so of banks and insurers that could be hiding

35:43

some liability on their balance sheet that nobody knows about.

35:46

CHRIS COLE: Now, what’s your take on it’s interesting because now, everyone wants to

35:51

go into passive investing.

35:53

Big, large cap stocks, liquidity, large cap tech stocks, that’s the rage, the Fangs.

36:00

It is very similar or reminiscent to the Nifty 50s bubble in the 1960s, where essentially,

36:08

everyone crowded into these blue chip stocks, and those stocks.

36:13

What’s your opinion on that?

36:15

What’s your view on that?

36:18

Really, in terms of where do you see opportunity in the different market cap segments of value

36:25

as well?

36:26

TOBIAS CARLISLE: Every boom has this echo of other booms in the past.

36:30

I think tech is always very sexy whether it was electronics in the ’60s, dot-coms in the

36:38

’90s, and now it’s software as a services, railroads, that was a ticket once.

36:43

CHRIS COLE: South Sea bubble, that colonies were a tech stock at the time.

36:49

TOBIAS CARLISLE: People were worried about traveling on railroads because they thought

36:53

if you went faster than the speed of a horse, you’d be atomized, which is terrifying.

36:57

That’s the stuff, that’s how tech of the day and that’s why it was so exciting for them

37:04

at the time.

37:06

The potential to be atomized, which probably there’s a lot of investors that hate it like

37:10

that.

37:12

I think that every boom has some sort– you can draw analogies, they do look like other

37:18

booms in the past.

37:21

I think that probably because they’re driven by the same thing, there’s some potential

37:25

there to invest in some life changing or world changing technology that seems to earn very

37:32

high, maybe not very high profits, but seem to generate a lot of revenue and a lot of

37:36

growth at least over a period of time.

37:38

It looks like it’s going to wash everything away that exists.

37:40

That was the argument of the dot-com boom.

37:44

These dot-coms are going to come in and they’re going to wash away everything that’s gone

37:46

before them.

37:47

Instead what happens is all the incumbents just adopt.

37:50

If I need to do is make a webpage or they had just adopt those business practices, then

37:56

the market goes back to the way that was before where everybody’s competing pretty much on

37:59

a level playing field and that’s a better period for value.

38:03

The market seems to– all the performance in the market has been those very large cap

38:09

tech stocks, but they have been the ones that have performed very well have been ones that

38:13

generate a lot of– they have actually generated some profits and some very good revenue through.

38:18

Amazon, Facebook, Apple, Netflix, but Netflix is still growing at a very high rate.

38:25

Google, if I didn’t mention Google.

38:30

They are very profitable.

38:31

They are very good businesses for the most part.

38:33

They’re expensive, but they’re not extremely expensive.

38:36

I think that some of the real overvaluation, the really egregious overvaluation is in some

38:42

of those out there.

38:43

I think Netflix has more of that egregious overvaluation.

38:46

Tesla, certainly very egregious overvaluation.

38:48

CHRIS COLE: You talked about this tech effect, this idea that people– I hear this all the

38:53

time among a lot of millennials where it’s different this time, the valuation’s different

38:59

this time.

39:01

We’ve had a transformative change in technology, the iPhones have changed, the smartphones

39:07

have changed everything.

39:08

This is a new era for technology, and yet value investing has survived through the ages.

39:14

Can you talk a little bit about is this a new era?

39:19

Is this different?

39:20

Has it changed, or will we seek a reversion of the mean in the same framework?

39:24

TOBIAS CARLISLE: There are some compelling arguments for why things may have changed.

39:30

I don’t know that this is the first time this has happened, but there may be changes in

39:33

the market.

39:34

There is some parallels between in the 1920s when cars was introduced and everybody got

39:43

access to a car.

39:44

There was a period of time where roads were built up, the infrastructure for cars had

39:48

to be built up.

39:49

It was a very bad period to be a value investor and a very good period to be a more tech growth

39:55

type investor with cars being the tech of the day.

40:00

That lasted for about 16 years.

40:03

Then value investing returned and did very well and has done pretty well through the

40:09

whole period.

40:10

We may be looking at something like that where it’s just a maybe there’s a little change

40:14

in the structure of the economy or there’s a change in the structure of the market.

40:21

I don’t think that it means that value will stop working.

40:24

I don’t think that necessarily means that that change is a permanent change to the structure

40:30

of the market.

40:31

I just think that because the logic I think of value investing is so compelling, if you’re

40:35

buying something for less than it’s worth, that should be recognized by the market over

40:40

a period of time.

40:42

Perhaps our definition of value has to change a little bit to keep up so profitable book

40:46

value, or the traditional metric for academics, particularly, some practitioners, maybe Walter

40:51

Schloss was more of a book value investor, but I think that he did some other things

40:56

on top of that, as well, but he was more maybe like an early quant where he have quite a

41:01

diversified portfolio of low price to book value stocks.

41:06

He did very well employing that strategy.

41:09

I still think you can do very well employing that strategy to the extent that there’s underperformance

41:14

now.

41:15

It’s pretty easily explained by the way that tech stocks are looking very sexy and they’ve

41:21

run very well.

41:22

A lot of investors look at the trajectory of the price only.

41:27

Something’s gone up a lot, that’s a reason to buy it, because that means that it will

41:31

continue to go up in the future.

41:33

Whereas value investors take the view that you have to look at the opportunity and buy

41:36

it at a discount to the opportunity.

41:39

All of those companies that have those ski jump price returns, they almost invariably

41:46

come back to Earth.

41:47

Not all of them have come back to Earth yet so I can’t say that they always do, but excluding

41:51

the ones in the current crop, that’s always been the case in the past that it get to that

41:55

point where they’re vertically ramped, there’s nowhere else to go, then that brings them

41:59

back to Earth.

42:00

I think that that’s likely to happen to certain stocks, and I think that often that’s the

42:06

precipitating event that leads to value, then having a very good period where we will come

42:12

back to our senses a little bit and try and buy fundamentals and cashflows and remember

42:16

that the function of business is to provide a service, to provide a product, to provide

42:22

some consumer surplus but also to reward the shareholders in those businesses for putting

42:29

capital at risk.

42:30

CHRIS COLE: We know, or we get a sense that the outperformance of value, the rebound value

42:36

that we’re seeing traditionally, has been a precursor to regime shift in markets.

42:43

That value has performed better at the end of a cycle, obviously, than growth and momentum

42:49

and that’s in the deflationary sense.

42:52

Let’s just imagine that we end up having a very progressive government, and even more

42:59

radical Fed than we have now.

43:02

There’s widespread money printing, fiat devaluation and we go into a stagflation airy crisis,

43:09

reminiscent of maybe the 1970s, how does value perform in that type of environment?

43:13

TOBIAS CARLISLE: How would the Fed be more radical than this interest?

43:18

I think that that scenario– CHRIS COLE: Well, you might be surprised.

43:22

Be careful what you want to tempt.

43:23

Don’t tempt the gods, please.

43:24

TOBIAS CARLISLE: I think we’re probably going to see it.

43:27

Whatever you think is, every year is going to be weirder than the last I think for the

43:31

foreseeable future.

43:33

I think that that scenario is probably a very good one for value.

43:36

Any volatility is good for value, anything that makes better balance sheets, more careful

43:45

managements, better businesses, perform better relatively two other companies that are out

43:53

there will be good for value investors.

43:55

I think that higher interest rates, a tougher business environment would certainly be a

44:01

very good environment for value guys.

44:04

I think that when we’re in very low interest rates, lots of liquidity, it’s hard to measure

44:10

what impact that has on the business because you see for a venture capital firm invests

44:16

in a tech company that then spends a lot of money on advertising, that money flows through

44:20

to Facebook and to Google, where advertising driven businesses used to be pretty cyclical,

44:26

pretty boom and bust, they’ve looked more secular recently, because there’s been that

44:29

move away from traditional television advertising to Google and Facebook.

44:35

The cycle hasn’t been as pronounced, it’s certainly been pronounced for the traditional

44:39

media, hasn’t look so good for them.

44:42

I think that potentially, very good for value and I would love to see it.

44:47

CHRIS COLE: It’s interesting as rates go up, volatility comes back in the markets, and

44:52

then the cost of capital is obviously much higher, and then I’m not getting a ride to

44:58

half [indiscernible] at half the cost of what it takes to take a train.

45:03

I think that that really segues in.

45:06

To that point, though, it’s interesting, this idea we think about this is Google, Facebook,

45:11

are these tech companies or are they advertising companies or in what the component that used

45:17

to be advertising agencies and more cyclical than we would think?

45:22

The one question I want to leave you on, the Fang stocks.

45:25

At what point will Tesla, what scenario, what point in history when do you think will Tesla,

45:34

Netflix, all these Fang stocks, Facebook, when will they become value stocks?

45:40

When would you see that happening?

45:41

TOBIAS CARLISLE: Well, I wouldn’t say that– almost every stock has its turn, has its regime

45:47

come to an end.

45:49

Buffett has been criticized in the past for not buying whatever is the fad of the day,

45:54

but if you look at his history, he has tended to buy a lot of these companies that are better

45:59

companies just after the crash or after they stub their toe and they look a little bit

46:05

less undefeatable.

46:07

At the moment, it looks like Netflix can’t be headed, Facebook can’t be headed, but I

46:14

think that the thing that created Facebook, for example, I think the kids don’t like to

46:21

be on the same platform as their parents or as the old and so Instagram arises, Facebook

46:28

sensibly buys Instagram, and so did the beneficiary of being the owner of Instagram where a lot

46:34

of attention moved.

46:36

I think attention moves away from Instagram now towards Tick Tock or something like that.

46:40

Those companies, the growth slows, but they’re probably still very good businesses.

46:46

They’re pretty low asset intensity, generate lots of free cashflow, reasonably stable,

46:53

growing businesses.

46:54

That’s exactly the thing that you would like to buy but at a price.

46:57

I don’t want to pay for all of that speculative growth and then I want own.

47:03

If anything, I don’t want to pay for the growth at all, I’m going to pay for them on their

47:05

current earnings power, with maybe a little growth in it because if you do a statistical

47:11

analysis on companies that the numbers that can sustain these very high rates of growth

47:17

are very low.

47:19

It’s one in 100, one in 200, which means that there’s probably there are 10 or 20 in the

47:26

Russell 2000 so there are a few of them around.

47:28

The problem is that everybody knows what they are.

47:30

They are bid to the moon.

47:32

You’re basically betting on the fact now that they are in fact better than everybody thinks

47:37

that they are.

47:38

I think that’s a very long vol at this point in the cycle, I think more likely, people

47:44

have overestimated what these things are worth, how far they can grow.

47:48

The they talk about the total addressable market for many of these businesses being

47:53

enormous, but what they forget is that the total eventual supply is going to be pretty

47:56

big too.

47:57

There’s going to be competition for those dollars.

48:01

When the market moves, value investors have to move along with it.

48:04

I think value follows along behind the wave where we’re picking up the detritus as it

48:11

comes back.

48:12

There just hasn’t been a lot around.

48:13

It’s been hard to find undervalued stocks.

48:15

I look forward to it, say it again.

48:17

CHRIS COLE: It’ll be like 2000, 40 Google’s regulated as– its regulated and broken up

48:24

AT&T as a Tesla utility, and all of a sudden, it’s trading a sub-depressed PE multiple to

48:30

whatever the next thing is.

48:31

TOBIAS CARLISLE: That’s so good to take that [indiscernible].

48:33

CHRIS COLE: Exactly.

48:34

Toby, it’s been a pleasure.

48:37

I know we’ve done this many times together outside, but this is a fun to do this on a

48:41

camera.

48:44

Toby Carlisle, Acquirer’s Fund.

48:47

Toby, where can people find you on Twitter and your website as well?

48:50

TOBIAS CARLISLE: I’m on Twitter @greenbackd, which is a funny spelling, it’s G-R-E-E-N-B-A-C-K-D.

48:56

My fund is the Acquirer’s Fund and the tick is ZIG, it’s listed on the NYC.

49:02

It’s a long/short net long to the tune of 80% or 100%, depending on where we are in

49:09

the cycle.

49:10

We’re about 80% exposed at the moment.

49:12

We have some shorts in that too, and we tend short as I said before, the junkier companies.

49:17

You can also find, I have a podcast and various other things on acquirersmultiple.com with

49:22

free screen, and I’m active on Twitter all day long, so I’m happy to engage, talk with

49:27

anybody on Twitter.

49:29

CHRIS COLE: I guess we got to show the viewers your daughter’s bracelet.

49:32

TOBIAS CARLISLE: Yeah, that’s from my six-year-old, made that while I’m away, I can remember.

49:39

CHRIS COLE: I think we can’t end on anything better than that.

49:44

I can’t top that.

49:45

Thank you.

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