The Acquirer's Multiple: How the Billionaire Contrarians of Deep Value Beat the Market

by Tobias E. Carlisle

you want the market return, buy the market. If you want to beat the market, you must do something different. That means buying only undervalued stocks, or concentrating. The trade-off for concentration is twofold: Concentrated portfolios tend to be more volatile than the broader stock market. This means they move around more, both up and down. Good days for the market can be great days for the portfolio. Bad days for the market can be terrible days for the portfolio. Concentrated portfolios don’t track the market. This is known as tracking error. It means concentrated portfolios can go down when the market goes up and up when the market goes down. The second kind of tracking error—portfolio up, market down—is the good kind. But you won’t notice. In practice, you’ll only notice when your concentrated portfolio is down while the market is up. Academics have found high tracking error is associated with good long-term performance. But the market can beat portfolios of undervalued stocks for a long time. Tracking error won’t feel good then. No one said it would be easy. Zigging is hard. Our guts scream at us to zag with the crowd. We know we should zig. But undervalued stocks are hard to buy. They own bad businesses. The growth has slowed, and the profits are falling; they’re losing money, or they’re headed to liquidation. That’s why they’re undervalued.