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

by Tobias E. Carlisle

Operating earnings are the income flowing from a business’s operations. It excludes one-off items like sales of assets and legal settlements. We adjust operating earnings for interest and tax payments because they are af...

For nonindustrial businesses like financials, such as banks and insurers, book value is the better single measure. Whatever the proxy, the goal is deep undervaluation.

Second, on the balance sheet, we favor cash and other liquid securities over debt. We watch for off-balance debts like leases and underfunded pensions. We look for credit issues and signs of financial distress.

The best place to find future growth and profit is in businesses enduring hard times. These businesses are also likely to trade at a wide discount to value. Buyers of these businesses can enjoy both an improvement in the business and a narrowing of the market-price discount.

Concentrated portfolios tend to be more volatile than the broader stock market. This means they move around more, both up and down. Good years for the market can be great years for the portfolio. Bad years for the market can be terrible years for the portfolio.

Don’t become too concentrated. Assume your calculations and thinking are wrong. Remember, it’s more likely you are wrong and the rest of the market is right.

Thinking long term—beyond the next few quarters or years—offers a huge advantage to investors. Companies often become mispriced because the next year or so looks tough. This creates a good spot for investors willing to lag over the short term. We call this time arbitrage. It offers an enduring edge available to patient investors, no matter the size of their portfolio.