Beat The Market With The Acquirer's Multiple: Review, Performance and Backtest

Developed by award-winning author and CIO of Acquirers Funds Tobias Carlisle, the Acquirer’s Multiple is an investing technique that focuses on the use of EV / EBIT valuation ratios to find companies with high earnings yield. In his book that outlines the strategy, Carlisle claims that this ratio is consistently used by activist investors like Carl Icahn, David Einhorn, and Dan Loeb to find deep value investments.

Carlisle’s philosophy when developing The Acquirer’s Multiple strategy was based upon finding the simplest multiple that could model the true cost of a stock, allowing him to reliably find stocks with a large margin of safety and subsequently, the best chance at mean reversion.

The Acquirer’s Multiple looks for companies trading at low valuations, typically great candidates for acquisition, whether from activists, private equity firms, or competitors. In Carlisle’s eyes, the strategy's ability to find undervalued companies in conjunction with mean reversion are its main benefits.

The Next Magic Formula?

Joel Greenblatt’s The Little Book That Beats the Market introduced quantitative, rules-based investing to the masses. Within his "little" book, Greenblatt lays out what he calls The Magic Formula, a strategy that focuses on acquiring both undervalued and high performing companies.

In a nutshell, the Magic Formula looks for:

  • Quality companies and thus, high Return on Capital

    ROC (Return on Capital):

    ROC-1

  • Undervalued companies and thus, high Earnings Yield relative to Enterprise Value

    Earnings Yield:

EV

Companies within the screening universe are then ranked. The companies that have the best mathematical combination between quality and low value are at the top of the list.

Coincidentally, Carlisle came up with the idea of the Acquirer’s Multiple while writing a chapter about The Magic Formula in his book Quantitative Value. He realized that by removing the strategy's quality filter (high ROC), he could simplify The Magic Formula and achieve better returns.

In short, the Acquirer's Multiple looks for just high earnings yield relative to enterprise value while The Magic Formula looks for both high earnings yield relative to enterprise value and a high return on capital.

The Acquirer's Multiple: Backtest And Performance

According to the backtest conducted by Tobias Carlisle in his book, the acquirer's multiple has outperformed both the S&P500 and Greenblatt's Magic Formula.
If you had invested $10,000 in the 30 shares with the lowest EV/EBIT and a minimum Market Cap of $1 billion in 1973 you would have achieved a CAGR of 17.9% beating the market to a large extent. The strategy has also a higher Sharpe Ratio, so it is a better choice even from a risk-adjusted return perspective.

Acquirer's Multiple Performance and backtest 1

Acquirer's Multiple Performance and backtest

Source: Tobias Carlisle Paper

Furthermore, Josh Payne of Quantopian performed a quantitative analysis comparing the performance of the two strategies, concluding that the Acquirer’s Multiple can outperform The Magic Formula based on the distribution of their daily returns.

Acquirer's Multiple Quantopian

Source: Quantopian

At Odds With Buffet?

It’s key for novice investors to note that the ideas behind the Acquirer’s Multiple don’t live with those of Warren Buffett’s current philosophy of buying great businesses at a fair price. Instead, this strategy focuses on buying fair businesses at great prices.

“Why do fair companies at wonderful prices beat wonderful companies at fair prices? Because great businesses don’t stay great. They only look great at the top of their business cycle. Mean reversion pushes great business back to average.”
-Tobias Carlisle, The Acquirer’s Multiple

Further, Buffett has said that Berkshire won’t buy companies who use EBITDA in their financial statements, due to the ability to ‘dress up’ a financial statement with the use of EBITDA.

“We won’t buy into companies where someone’s talking about EBITDA. If you look at all companies and split them into companies that use EBITDA as a metric and those that don’t, I suspect you’ll find a lot more fraud in the former group. Look at companies like Wal-Mart, GE, and Microsoft — they’ll never use EBITDA in their annual report.”

- Warren Buffett, Berkshire Hathaway 2002 Annual Shareholder Meeting

The Use of Enterprise Value

Unlike more traditional valuation multiples such as price-to-earnings ratio, the Acquirer’s Multiple uses enterprise value, which takes into account the equity value and net debt, providing a view of the "whole iceberg" when it comes to a company’s true value.

iceberg

Carlisle explains his preference for using enterprise value in favor of equity value here:

“If we spend $10 million buying the company that owes $5 million in debt, we now own a company with $5 million in debt. We have to service the debt. What we can take out of the company will be cut by the cost to carry the debt until we pay it off. What about the company with $5 million in cash? If we spend $10 million buying that company, we can immediately use the cash and any profits. The company only cost us $5 million because we got the cash back.”
-Tobias Carlisle, The Acquirer’s Multiple

Acquirer's Multiple With The Finbox Screener

In this article, you discovered that you can beat the market using a very simple formula. Carlisle has a paid membership site where you can find the top 30 stocks using the Acquirer’s Multiple. But don't worry, you don't have to pay for anything at all. All you have to do is to sign up for free at Finbox and create your own portfolio that beats the market with our powerful tools. Just follow these simple steps:

1) Sign up for free at Finbox

2) Go to the Finbox Screener.

3) Click on the "+" button to add a metric

Finbox Screener

4) Select the “Market Cap” metric, if not already selected.

5) Click on the green "+" button

Finbox screener button

6) Add the Enterprise Value / EBIT metric

Finbox screener metric

7) Now that you have your list of stocks, sort them by the lowest EV / EBIT values by clicking on the Enterprise Value / EBIT tab.

Finbox screener EV ebit

8) Select the first 30 stocks

There you go, now you have a portfolio that beats the market.

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