Evaluating the Source of Returns: Thinking as a Business Owner Instead of a Stock Picker
“Do I care if the market recognizes the value I see in these companies after I buy them? No, I don’t.”
I’ve followed Tobias Carlisle’s work for a while. His “deep value” mindset really resonates with me.
(You should read his work at acquirersmultiple.com)
If I had to translate what I think is the overarching theme of “deep value” investing as a layman and non-professional, the way I would do so is by arguing for buying stock in companies that do the right things operationally but do not receive credit for it on Wall Street.
The reasons these companies do not receive proper credit are complicated and complex, but for the most part, there is a narrative written against them by Wall Street analysts: they’re boring companies in non-growth sectors, and as a result they are ignored.
The goal of value investing, which I see as inherently defensive if you are doing it right, is to find undervalued assets. Once you find those undervalued assets, you buy them and allow them to work for you to return your investment over time.
What most people miss is when they find something they feel is undervalued, their intended catalyst to obtain a return is that the stock market will realize its mistake and re-rate the price higher. This puts a faith in others and systems I don’t necessarily feel comfortable with.
Tobias Carlisle was a guest on the Excess Returns podcast in April.
The entire interview is great, but my focus is around the 10-minute mark. Tobias goes into detail about the line of thinking described above.
“It doesn’t matter if you get a multiple re-rating if you are getting incremental reinvestment by the company.”
He then lays out the formula he uses to evaluate internal return:
Marginal Return on Invested Capital + Dividend Yield + Buyback Yield = Return
“When I think about this stuff, I don’t actually care what the market does. I always invest on the assumption the market is NOT going to re-rate the stock.”
He continues:
“And for companies that are doing a lot of buybacks, I would actually prefer if the market DOESN’T re-rate the stock because I’m going to make a lot more money, ultimately, if they stay cheap and continue to buyback stock.
Do I care if the market recognizes the value I see in these companies after I buy them? No, I don’t. Because I am already receiving a return via their reinvestment, dividends and buybacks.”
The name of the game in investing is buying cash flows as cheaply as possible.
It’s the same as buying your local convenience store: if you were talking to the current owner, would you want to know how much your neighbor thought the business is worth? Would you care how much some guy halfway across the world thinks it is worth?
No, you’d want to know how much cash the business brings in each day, month, quarter, year, etc., and how much of that cash comes to you as the owner.
If the market re-rates your company up, that’s certainly a pleasant surprise as well, but it should be treated as a bonus and not the main focus.
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