In the early 2020s, skepticism toward value investing surged. As Tobias Carlisle noted on the Excess Returns Podcast, “In 2020 and 2021, the growthy, better-quality companies were having a field day, and value was again being left behind.”
Critics argued value investors were merely price investors, relying on multiple expansion rather than deep fundamental analysis. This critique led Carlisle to reevaluate his investment approach.
“I went back to the drawing board and realized I probably did rely too much on multiple expansion,” he admitted. He found that value stocks are often mispriced because “these businesses often don’t perform as poorly as everyone expects, which is why they’re cheap in the first place.”
But he wanted to determine whether returns could be generated without relying on multiple expansion.
His solution? A valuation approach centered on reinvestment and shareholder yield rather than speculative multiple expansion. “One approach is to look at the return drivers of any investment, which can be broken into two factors: reinvestment and shareholder yield.”
The reinvested portion attracts the same multiple as the current trading multiple, ensuring returns come from business growth rather than price speculation. The remaining portion returns to investors via buybacks, dividends, or capital returns.
Carlisle implemented this approach over the past five to six years. “I now use two valuations: one is a DCF, which implicitly includes some multiple expansion, and the other assumes no multiple expansion. By comparing the two, I can determine whether an investment would still be satisfactory without multiple expansion.”
This strategy has proven valuable. “In 2020, it was clear that small-value portfolios were going to generate better returns purely based on reinvestment and flows, with no multiple expansion.”
Following the recent market selloff, he sees a similar opportunity. “The quality of the businesses is high, and by my definition, quality is the ability to reinvest and have that reflected in the stock price, assuming no multiple expansion.”
Carlisle’s refined philosophy presents a compelling case for value investing. By focusing on reinvestment and cash flows instead of betting on multiple expansion, investors can identify opportunities where “just the reinvestment and flows alone can deliver greater returns than the market.”
This disciplined approach provides a reliable framework for long-term success in a market prone to extremes.
You can watch the entire interview here:
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