Norman Rothery is the value investor for Globe Investor's Strategy Lab. Follow his contributions here and view his model portfolio here.
Carl Icahn is trying to squeeze a little more juice out of Apple. Late this week, he released what amounted to a love letter extolling the virtues of the company and urging it to repurchase more of its stock.
The move follows a similar push last year that saw the company return money to shareholders by raising its dividend and buying stock. This time around management appears to be a little less co-operative. But I wouldn't count out Mr. Icahn quite yet. While he sometimes fails to get companies to follow his advice, he has a knack of walking away with piles of cash, nonetheless.
You can learn more about activists like Mr. Icahn by reading money manager Tobias Carlisle's new book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations. It explores the modern development of value investing and uses the careers of famous activists to show how it has evolved.
Fans of Mr. Carlisle's previous book, Quantitative Value, will also appreciate the market research he sprinkles throughout Deep Value. But the numbers play a supporting role in this case.
At the core, Deep Value revolves around two basic value investing strategies. The first being Benjamin Graham's net current asset value method that looks for companies trading for less than two-thirds their current assets less all their liabilities, which is a rough measure of their liquidation value.
The main problem with Mr. Graham's approach is that very few stocks pass the test in normal times and those that do tend to be quite small. As a result, it places the strategy firmly in the domain of individual investors rather than institutional ones. Nonetheless, it has performed remarkably well over the long term.
But the second method recommended by Mr. Carlisle scales up to larger portfolios. It's based on what he calls the acquirer's multiple, which is the ratio of a firm's enterprise value (the market value of a company's equity plus net debt) to its earnings before interest and taxes (EBIT). You can think of the multiple as being something like a price-to-earnings ratio, with price replaced by enterprise value and earnings by EBIT.
Buying a basket of stocks with very low multiples has been quite profitable over the long term. He reports that a portfolio containing stocks with the lowest 10 per cent of multiples (the value decile), rebalanced each year, returned an average of 12.50 per cent annually from 1951 to 2013. By way of comparison, the market gained 8.36 per cent a year over the same period.
Mr. Carlisle also goes a step further and divides the value decile in half. Stocks with the lowest multiples are put into the deep-value portfolio, which gained 15.72 per cent on average from 1951 to 2013. The value stocks with higher multiples are put into the amusingly named "glamour value" portfolio. They advanced only 8.84 per cent per year and outperformed the index by a meagre 48 basis points annually.
I was, frankly, surprised at how poorly the glamour-value stocks fared. The reason for their lacklustre performance can be explained to some degree by looking at the average multiple of the stocks in both categories. The deep-value portfolio's average multiple was a very frugal 3.9 whereas the glamour-value portfolio was much higher at 8.2.
Over all, Mr. Carlisle makes the case that value investors should be very wary of paying up for stocks with pleasing characteristics. Call it the revenge of the cigar-butt stocks because the market's castoffs have provided excellent returns over the years.
If you're a value investor or are simply interested the sort of thinking behind Mr. Icahn's latest round of activism, then you'd do well to pick up a copy of Deep Value. It'll help you become a better investor.
Norman Rothery