The State Of Value Address – Is Value A Value Trap?

During their recent episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discussed Tobias’ article titled – Is Value A Value Trap? Here’s an excerpt from the episode:

Tobias Carlisle:
All right. So I wrote it for … it’s up on the acquirers multiple website. I’ll link to it in the show notes to this straight after we record it. I called it, Is value a value trap? Because I don’t know, everybody’s got a different definition of a value trap but I think my definition of a value trap is something that keeps on going down in terms of the price, and every time you go to look at it, the intrinsic value is down too but the price is still discounted to the intrinsic value. And so you feel like you shouldn’t be selling it because it’s still cheap. And it just keeps on doing that until all your money’s gone. So I looked at value … and so that’s the question that I have, is value just a melting ice cube? Is it that these portfolios are just getting junkier and junkier and we’re reforming at a lower point every time but they’re worse portfolios and so you don’t want to hold them at all?

Tobias Carlisle:
So Cliff’s piece was really good in digging into, are these unusually bad portfolios? Is it … like the return on assets question. So they’re no worse than they usually are over full data set. Are they more levied? So his analysis left a few guys asking, “Does this satisfy that answer?” So I took a look at that in the context of EV/EBITDA and EV/EBIT. So what I did, I pulled the data off the visual factors page on the alpha architect side, which runs each of the metrics, price to cash flow, price to earnings, price to book. EV/EBITDA, EV/EBIT over the data set back to 1992, which is a good one because that’s modern history where … people say, “What happened in 1940s is not relevant. What happened in 1960s is not relevant.” But 1992, today, I think is a long enough data series to give you some idea what’s going on. But it’s mostly modern history. It’s mostly-

Jake Taylor:
Was ’92 the last time that value worked?

Tobias Carlisle:
No, it’s worked a few times in that period. But that’s a fair question. Not much over the last 30 years, basically. Basically, it’s underperformed 70 to 80% of the time over the last 30 years. Even though it’s outperformed over the full data set, that’s weird, get your head around that one. 70 to 80% of the time, it’s in a drawdown. But you still win over the whole thing. That tells you something about value, and that tells you why it’s so hard to hold on to it. I mentioned that in the piece. But basically, what I did to workout whether these things are cheap or expensive, it’s hard. Do you adjust by interest rates? Do you adjust it by other things? I don’t know. So what I did was I just ran them back against their own averages. So where … if a P is 10 today, and it’s traditionally a P5, you would say that’s twice as expensive. So that would not be a good opportunity for value. If it’s usually 10 and it’s currently five, then it’s a better opportunity than it usually is, value’s cheap.

Tobias Carlisle:
So I looked across every single one of the data sets. In every single instance, value is above average opportunity. It’s rich to its mean which means it’s a good opportunity. In two of them, so price to book value is about 65% rich, which is about as high as it’s ever been. The only time it’s been high was March 31. So this data goes to April 30, month end. The only time it’s higher was March 31, which makes sense, we’ve bounced a little bit off the low. That’s true also for price to earnings. The only one that doesn’t look great is price to cash flow, which is about 5% rich. But that’s still better than two thirds of the time. So one third of the time it’s been better value. It’s hard to know which of those metrics you want to lean on the hardest. So I just took an equal weight average of all of them and I caught the combo and I stuck that together.

Tobias Carlisle:
If you just equal weighting each of those metrics, the combo says we’re about 35 and a half percent rich to the long run average. And the only times that it’s been a better opportunity than this … there are six month ends out of 340 through that whole data set. There are five right at the very peak of the dot com bubble. And there’s one March 31, a month ago. So, I would say that value is a very good opportunity right now. The question about whether the portfolios are unusually levied or not, I think is answered by EV/EBITDA and EV/EBIT. So EV/EBITDA is about 25% rich. And it’s like they’re 4% of occasions, which is about 10 months that we’re better than this.

Tobias Carlisle:
And they’re all like 2000 EV/EBIT. There are a couple more, it’s in about the 10% of opportunities, but they’re all clustered around the 2000 peak and the 2007 Peak. So I think on just about any metric value looks very very cheap to me and across all of them It looks cheap, the portfolios aren’t unusually livid. And the main takeaway for me which I found really surprising was that value has underperformed. 70 to 80% of opportunities over the last 30 years and still outperformed over the full data set. So that’s interesting.

Jake Taylor:
Yeah, frequency versus magnitude.

Tobias Carlisle:
Exactly right.

Jake Taylor:
So good luck trying to time that and missing out on it.

Tobias Carlisle:
That’s right. Like you really have to be invested in it to capture those returns, you have to know that .They really do come about infrequently. And when they come about, there’s so big that if you miss them, then you miss out on all of the value of valley, all of the out performance of valley.

Jake Taylor:
That makes sense. It probably should be easy.

Bill Brewster:
It’s like Adam Don.

Jake Taylor:
[inaudible 00:11:47]reference.

Bill Brewster:
I said it’s like Adam Don right strikes out a lot, but when he hits it’s out of the park walks a lot too, but anyway, doesn’t matter.

Tobias Carlisle:
One of the other interesting things so I pulled in a whole lot of research from … I looked at some Olson research, I looked at AQR research, I looked at Cory Hoff Steen had this piece on why book value looks so busted and whether you can discount that or not the same piece on on unpacking the problems with book value, which I thought was pretty interesting. I think there’s an awesome piece that was really interesting that they call factors from scratch with a look at what drives value what drives growth. So, when you form a value portfolio, they tend to be subnormal profitability and the profitability tends to fall over the course of the time that you hold the portfolio. And then when you rebalance, you rebalance into a cheaper portfolio so has this sawtooth where your earnings are falling while you’re holding it. And all of the gain from Valley comes from multiple rewriting and the way that you can think about that is there’s already sub normally cheap portfolios, people oversell them because they don’t want to be in something that’s falling and sub normally profitable.

Tobias Carlisle:
But they overestimate how bad they are. So that’s the way it works. For growth, it’s the opposite, the earnings of growth portfolios do go up. It’s just that we tend to overpay, the difference has been over the last 10 years or so. So depending on when you start the under performance starts in about 2006, for price to earnings and like 2014 for price to cash flow. Basically, that multiple expansion and compression has gone away. So growth has seen the multiple expansion, in addition to rising earnings growth has seen multiple compression in addition to falling earnings. And that is driven though, that the alligator jaws really wide and send out values is unusually cheap growth is unusually expensive.

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