In their latest episode of the VALUE: After Hours Podcast, Taylor, Brewster, and Carlisle discuss Acquirers Multiple All-Time Spread. Here’s an excerpt from the episode:
Tobias: I just have been interested like value’s the thing. My definition of value, The Acquirer’s Multiple has been sucking wind a little bit for since about May last year. I was just interested to know what happened because we keep on hearing as the spread is wide. What does that mean? The spread is wide. So, I just looked at a combination of these things sales, cashflow, book, earnings, and EV/EBIT, which is The Acquirer’s Multiple. What’s interesting is sales, and book, and cashflow have all come in pretty significantly the spread since cashflow didn’t really ever get that blown out, but sales and books certainly did. That’s why you come back in the spread.
Jake: You mean top decile versus bottom decile difference?
Tobias: Yeah.
Jake: Okay.
Tobias: Exactly. Thank you for clarifying. I should have said that.
Jake: it’s okay.
Tobias: They’ve come in pretty materially since September 2020. But the two that have blown out and consistently blown out and I don’t know why they would be so different. Because I can understand why book doesn’t work and cash, I don’t know. But sales and there should be a pretty strong relationship between sales and EBIT earnings eventually. The EV/EBIT has blown out much, much wider than it was in the dotcom peak. Much, much wider than it was in 2007, 2009. It’s basically the widest we’ve seen.
The interesting thing about US EV/EBIT is, it is comparably wide to the rest of the world which is not true of the other value factors. They all seem to come in while there’s other ones have blown out. Typically, wider spreads mean better returns are coming in the future. But I’m just interested to know. What do you guys think? Why would those two keep on blowing up while the other two would come in so consistently?
Jake: We have a hypothesis on what’s the difference between P/E and EV/EBIT? Really, it’s-
Tobias: Debt.
Jake: -debt.
Bill: And taxes.
Jake: And taxes, but if there was an interest, I guess, too. On the debt side, I think we’ve seen a junk rally if you will, and I noticed comparing one particular ETF that you might be familiar with Toby, that you might even manage compared to RZV, which is just a small cap general value index. Yours is a little bit higher quality cut relative to maybe a little higher debt loads for some of the RZV. It’s been interesting to watch how they move a little bit different from each other, and I noticed the debty ones did a little better, and I wonder if it was from existential crisis of 2020, if you have a heavy balance sheet, and then there’s a little bit of question marks about what you’re going to survive, you’re going to get crushed. Now, it’s like, “Okay, they’re probably going to survive” and you see that bounce back. So, therefore, a less aggressive EV/EBIT than does maybe relatively not as good because they were never as in much existential crisis.
Tobias: There’s a composition element, too. There’s a lot of energy, and heavy industry, and there’s others I guess, particularly book.
Jake: Yeah.
Tobias: Book’s going to look a lot healthier when energy spikes financials, too.
Jake: Yeah.
Tobias: I don’t know. It’s interesting. I think it’s good news, because I think there’s a lot of returns coming and we’re very, very early in the cycle to the extent that the spread might not even have started closing.
Jake: Yeah. So, early. It’s not even started. [laughs]
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One Comment on “Acquirers Multiple All-Time Spread”
The Acquirer’s Multiple works because it provides a quick approximation of a discounted cash flow model. 90% of my investments use a modified Acquirer’s Model. I use EBITDA rather than EBIT because amortization is an accounting item that may distort operating income. It totally fails when it comes to intangibles. It is useful for airlines and trucking companies where there is continuous replacement. My second modification is using forward estimates rather than historical data. Take a stock like Cleveland Cliffs that made two acquisitions in quick succession that took the operating income from $500 million to $5 billion. The historical data was irrelevant.
I have also bought and sold a lot of commercial real estate over the last 30 years. Almost all commercial real estate is valued and traded based on a multiple (Cap Rate) of forward net rental income and that is essentially forward EV to EBITDA.
As for the Acquirer’s Multiple being a quick approximation of a discounted cash flow model, I first realized this when evaluating oil and gas companies 40 years ago. They annually report the value of reserves using very extensive discounted cash flow models. When I looked at the sale price of producing properties I noticed that they generally sold based on a discount rate of around 20%. I also noticed that in most cases this was around four times the net production income. Buying oil and gas stocks with forward EV/EBITDA below four was very worthwhile.
Jim