I wrote a piece on watchmaker Movado Group (MOV) for John Mihaljevic’s wonderful Manual of Ideas issue on Deep Value. Download it by clicking here or the cover below:

Manual of Ideas Deep Value

You can get a free list of the best deep value stocks in the largest 1000 names on The Acquirer’s Multiple.

Buy my book Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations (hardcover or Kindle, 240 pages, Wiley Finance) from Wiley Finance, Amazon, or Barnes and Noble.

Here’s your book for the fall if you’re on global Wall Street. Tobias Carlisle has hit a home run deep over left field. It’s an incredibly smart, dense, 213 pages on how to not lose money in the market. It’s your Autumn smart read. –Tom Keene, Bloomberg’s Editor-At-Large, Bloomberg Surveillance, September 9, 2014.

Click here if you’d like to read more on Deep Value, or connect with me on Twitter, LinkedIn or Facebook. Check out the best deep value stocks in the largest 1000 names for free on The Acquirer’s Multiple.

Robert Shiller’s cyclically adjusted price earnings (CAPE) ratio takes a 10-year inflation-adjusted average of the S&P500’s earnings to arrive at a price/earnings metric smoothed for the business cycle.

It’s useful because earnings tend to be volatile and mean reverting. For example, the single-year PE metric peaked in 2009 at 125, indicating that the market was expensive, when in reality it was one of the best times to buying stocks in the last 20 years.

Deep Value Presentation for MoneyShow.004

The reason the PE looked so high was because the “E”–earnings–had fallen so far.

Deep Value Presentation for MoneyShow.005

Shiller’s solution is to smooth the earnings by taking the 10-year, inflation adjusted average.

Deep Value Presentation for MoneyShow.006

The Shiller CAPE allows us to compare the smoothed earnings to the level of the market and arrive at a cyclically adjusted PE.

Deep Value Presentation for MoneyShow.007

The CAPE is currently about 60 percent over its long-run average. Half of the premium comes from earnings 30 percent above trend, and half comes from a single-year multiple 30 percent above its average.

The bulls argue that this premium is justified (or non-existent) because interest rates are low, earnings will stay elevated because US companies earn a greater share of income internationally, and the market has peaked at higher Shiller PEs in the past: 1929 peaked 33x, 2000 peaked at 44x, Japan got to 100x in the 1990s, and China has traded at 100x this year. They also point to the fact that the Shiller PE has indicated the market has been consistently overvalued since the 1990s, only briefly touching the long-run average in the depths of 2009.

John Hussman has a method for calculating 10-year expected returns from Shiller PEs that assumes mean reversion in the PE over the 10 years. The slide below runs the data back to 1871 and compares Hussman’s expected 10-year returns against the returns that actually occur.

Deep Value Presentation for MoneyShow.024

If we zoom in on the area under the blue circle, we can see that Hussman’s method has been predicting below average returns since the mid-1990s, with a deep trough in 1999, and a smaller trough in 2007.

Deep Value Presentation for.025

The first trough preceded the 2000 tech bust, and manifest in negative returns for that 10-year period. The second trough preceded the 2007-2009 credit crisis, but has not yet manifest in below average returns (returns are about average for the period), largely because the market has moved back into steep overvaluation. It wouldn’t take much of a move down (as the market has tended to do after below average expected returns emerge) for the actual returns to move down too.

The tool below draws data from Shiller’s site and updates automatically, so bookmark it for future reference.

In his Little Book of Sideways Markets, Vitaliy Katsenelson has argued for “secular” markets that emerge as the market moves between distinct Shiller PE peaks and troughs.

Deep Value Presentation for MoneyShow.014

The starred peaks below are the start of infamous crashes–1929, 1966, and 2000–and the circled troughs are the start of blistering bulls–1920, 1950, and 1982 (and maybe 2009 if the bulls are right). Katsrnelson argues that these secular turning markets appear as bull markets, and sideways markets (rather than bear markets–Katsenelson argues that 1929 is a special case because the market fell so far, ~90 percent).

Deep Value Presentation for MoneyShow.015

The returns in securlar markets are driven more by changes in the multiple applied to earnings, than earnings themselves, which have been consistently up.

Deep Value Presentation for MoneyShow.017

Earnings have grown pretty consistently over the full period.

Deep Value Presentation for MoneyShow.018

So changes in the multiple applied to the earnings has been the difference in returns.

Deep Value Presentation for MoneyShow.019

Of course, the level of the market is less interesting to value investors who are (or should be) focussed on the market’s undervalued dreck. Value seems to follow its own idiosyncratic path, correlated to, but distinct from the market itself. The interesting question is, “What happens to value stocks in sideways markets?” The three most recent sideways markets, which followed big bull markets, started in 1937, 1966 and 2000.

Deep Value Presentation for MoneyShow.035

Here we use Ken French’s P/B value decile and compare the returns to the S&P500 over the same period. (It’s not an entirely fair fight because the value decile draws from smaller stocks than the S&P500, but so can we, so that’s what I’m using.)

Deep Value Presentation for MoneyShow.036

Value made its own way, but it beat out the S&P500 over the full period. The 1966 to 1982 sideways market was a genuine bull market for value investors.Deep Value Presentation for MoneyShow.039

And the 2000s have been kind to value investors too.

Deep Value Presentation for MoneyShow.042

Of course, there’s nothing free in this world. The tradeoff for beating the market over the full period is big drawdowns and lots of underperformance. Look at the blockbuster drawdown for value in the early 1940s. You’d just about give the game away down 82 percent.

Deep Value Presentation for MoneyShow.037

1966 was more benign, but there were lots of drawdowns on the way to those great returns.

Deep Value Presentation for MoneyShow.040

2000 on has taken some wild spills too. 2009 was tough one.

Deep Value Presentation for MoneyShow.043

Value underperformed a lot in the 1937 to 1949 sideways market. At one stage it was 66 percent behind the market.

Deep Value Presentation for MoneyShow.038’66 was easier, but it lagged by 26 percent in the early 1970s.

Deep Value Presentation for MoneyShow.041

And there have several periods of underperformance over the last 15 years to get the great outperformance.

Deep Value Presentation for MoneyShow.044

If you’ve got the stomach for it, value is a great way to ride out a sideways market. (In a bull market, you just throw a dart at index and head to the beach).

If you’re going to focus on value, the acquirer’s multiple is the way to go. It’s beaten out book value (and every other metric) in the best data we have:

Deep Value Presentation for MoneyShow.047

Click here if you’d like to see a current list of deeply undervalued takeover and activist targets using The Acquirer’s Multiple® (it’s free!), subscribe to The Acquirer’s Multiple® or connect with Tobias on Twitter, LinkedIn or Facebook.

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See the output of the deep value investment strategy featured in the Amazon best-seller Deep Value:

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This month’s issue of Singular Diligence is about Hunter Douglas, the world leader in window coverings. HDG is based in the Netherlands. It generates the bulk of its revenue in the U.S. and Europe.

It divides its business into two segments:

1. Window Coverings, offering venetian and vertical blinds, roman, roller and woven wood shades, pleated shades, wood and alternative wood blinds, custom shutters, exterior venetian blinds, screen products, shutters and awnings;

2. Architectural Products, including sun control products, such as sun louvers, external louvered blinds, perforated screens, among others; commercial window coverings, such as roller shades, aluminum blinds, among others; ventilated facade systems; suspended ceilings systems; 3form translucent materials.

HDG operates under the brand names, such as: Hunter Douglas, Luxaflex, Duette, Silhouette, Vignette, Pirouette, Facette, Techstyle and 3form, among others. It has operating companies and offices worldwide in such countries as: Russia, Italy, Canada, the United States, Argentina, Mexico, Japan, Australia, among others.

Hunter Douglas is a good business at a great price. Its competitive position is very strong and the company is the clear market leader in blinds and shades in the U.S. and Europe. It is a hidden champion within its niche.

Click here to read more.

I like to check in occasionally to see where the S&P500’s average enterprise multiple stands. Right now it’s trading on just over 12x, where it’s been since the start of the year. It’s rarely been this expensive. Indeed, the average for the full period is 10.4, and it’s only exceeded this level in the late 1990s and briefly in the early-2000s.

The chart below shows enterprise value/trailing EBITDA for the S&P500 for the period 1990 to date:

Bloomberg EV:EBITDA Chart

The chart below shows enterprise value/trailing EBITDA for the S&P500 for the period 1990 to date compared to the S&P500:

Bloomberg EV:EBITDA Chart from Chris v2

One thing clear from the charts is that the level of the S&P500’s enterprise multiple is not particularly predictive of anything. Sure, it peaked in 1999 along with the market, but it also bottomed in late 2011, while the market bottomed in early 2009.

I prefer to use it as a rough estimate of the likely upper end of valuations for my basket of stocks. While they aren’t directly comparable (the acquirer’s multiple uses enterprise value-to-operating income, not EBITDA), they are close enough. The median of the stocks in the Large Cap 1000 screener currently sits around 7.9x (the most expensive sits at 9.3x, and the cheapest at just over 5x). That’s plenty of room for bigger acquirers to pay a premium and take them out.

Click here if you’d like to see a current list of deeply undervalued takeover and activist targets using The Acquirer’s Multiple® (it’s free!), subscribe to The Acquirer’s Multiple® or connect with Tobias on Twitter, LinkedIn or Facebook.


This month Singular Diligence covers Breeze-Eastern Corp (NYSEMKT:BZC) a manufacture of sophisticated engineered mission equipment for specialty aerospace and defense applications. BZC’s products are used to complete rescue operations and military insertion/extraction operations, move and transport cargo, and load weapons onto aircraft and ground-based launching systems. It’s an obscure, cheap stock in a duopoly. The extract below describes the company’s moat:

Breeze-Eastern has over 50% market share in helicopter rescue hoists. Outside of the former Soviet Union, it is part of a true duopoly with UTC Aerospace. Most customers believe they have only two choices for rescue hoists. They can either go with UTC or Breeze. It is important not to overstate the technical difficulties of this business. Breeze is a duopoly. And there are good reasons to believe it will stay a duopoly.

But there are not serious technical obstacles to overcome to enter the rescue hoist business. In fact, it is possible to modify a helicopter designed to work with a Breeze rescue hoist so it can instead be equipped with a UTC rescue hoist.

There are many more helicopter models than rescue hoist models. There is no need to design a completely new rescue hoist model for each helicopter model. A former Breeze-Eastern engineer told us: “In general I would say rescue hoists though somewhat customizable for each airframe in general the overall design was consistent. As with any aerospace product there is some uniqueness per aircraft whether it is electrical or mechanical interface or some unique performance requirement. But Breeze has a great baseline hoist that was easily modified as needed for the application.”

Breeze’s experience in cargo winches is probably similar to what a new entrant in rescue hoists would face. Breeze had a high initial investment. After this initial investment was made, Breeze hoped to invest much less in engineering each subsequent cargo winch project it worked on because it would have a base to work from. Here is a quote from a 2011 earnings call: “… we are using the engineering work that we’ve done for those in our bidding on other programs—so trying to use derivatives off of that with much less engineering—incremental engineering investment or effort than we had to make to do the from scratch development on a couple of those cargo winches.”

Although Breeze is part of a duopoly without a lot of change, it would be wrong to equate the technical challenges Breeze and its competitors face with something like what Babcock does in nuclear power components for the U.S. Navy. Rescue hoists are fairly simple. They only average a cost of about $250,000. There are not huge risks of cost overruns or delays in construction due to technical challenges. A rescue hoist is a niche product. But it is still a product. It is not a custom project. Historically, Breeze or UTC invested in all the upfront spending on designing a hoist to work with a certain helicopter. This is a big reason why the original equipment manufacturers do not mind a duopoly. They can choose from one of two companies who can offer a good solution. And those two companies will spend the necessary time and money on designing the hoist. The rescue hoist manufacturer then benefits from that new helicopter model specifying the hoist it is meant to work with. But, eventually, a popular helicopter model will be capable of working with a hoist from either company. This is because–eventually–the competitor who did not work on the helicopter when it was originally introduced does the necessary engineering work so it has a hoist that can work with that helicopter. The Sikorsky Blackhawk, Bell 412, Eurocopter AS350, AgustaWestland 109, and many other helicopters now work with rescue hoists from either Breeze-Eastern or UTC. So, a customer can buy a fleet of Blackhawks and then have its choice of which hoist to use: Breeze-Eastern’s or UTC’s. It’s not clear how important this choice is to the competitive position of the two companies. That may seem like a strange statement. But there are two facts to consider. One, when a new helicopter model comes out it generally has only one hoist meant for it. So, if you are an agency getting deliveries of some helicopter within the first few years of its introduction–you may not have a real choice. Also, customers—unlike the original equipment manufacturers–are focused on search and rescue. So, a customer might have 10 helicopters and even when buying a new model, they may still have 5 helicopters of a different model. In the Maryland State Police example we gave, they have a fleet of 20 helicopters split between 11 of one model and 9 of the other. A customer would not like to use one supplier for repair and replacement work on half the fleet and another supplier for repair and replacement parts on the other half of the fleet. Remember 90% of replacement parts are proprietary and the two companies’ parts do not work together. This preference may sound excessive. Airlines, militaries, government agencies, etc. frequently operate more than one model of airplane or helicopter in their fleet. Why not use two different kinds of rescue hoists? But there is an extensive distribution structure for even proprietary parts from most airplane and helicopter manufacturers. Remember, there is easily 10 or 20 times more helicopters out there than there are helicopter hoists. And there are far, far fewer helicopters in the world than airplanes. Logistically, it is much easier to service airplanes than helicopters. And it is much easier to service helicopters than to service helicopter rescue hoists. The inventory levels related to rescue hoists are very, very low. We know this because we can see Breeze-Eastern’s inventory levels and we know how long they take to get replacement parts to customers. We also know UTC is no better.

This is an area Breeze is working on. But, it is worth discussing the logistical problem caused by how small the rescue hoist niche really is. One customer told us: “My issue is that we equip all 12 of our helicopters with hoists and the operations are things we train extensively on. If a hoist is taken out of service we get very uncomfortable because one of our prime reasons for having them is to rescue our own firefighters from getting burned over by a forest fire or for getting an injured person in a remote area out for medical attention. I’m not sure either company gets that and it may be that the armed services have enough spares so that it never happens. The hoist is used because in almost all instances where it is used it is not possible to land the helicopter. So we don’t like having a helicopter available but no hoist. They don’t break often but they do break.” Another customer who complained about the lack of customer attention explained this problem is caused by the size of the addressable market: “UTC is the only manufacturer that makes the type of hoist we use and we selected (that hoist) for some very specific reasons. I suspect that things would be different if there were 5 manufacturers who made a hoist like this and they were interchangeable, with little or no work, but the market is too small for that to happen, so here we are.”

Customers know they can modify their fleet to use Breeze or UTC hoists. And several customers told us they have heard of people doing this. The reason for switching was always poor customer service. But the problem is that “there are significant changes in the fixed provisions” Fixed provisions are non – optional (required) parts. This point of fixed parts was stressed to us again and again by customers and engineers. For example, another customer told us: “…the external hoists from both manufacturers do not have any interchangeable parts. Wiring diagrams are also specific to each manufacturer. Each hoist type comes with a helicopter model specific flight manual supplement so these are also different between hoist manufacturers and helicopter models.”

So, it is not technically very difficult for Breeze-Eastern or UTC or anyone else with a good base hoist system to engineer solutions that work with different helicopter models. It is also not impossible for a helicopter operator to switch from one hoist to another. But there is an installed base of search and rescue helicopters out there. And each hoist manufacturer’s replacement parts only work with their own hoists. This discourages switching between hoist suppliers. If an operator believes the two companies offer roughly similar solutions the obvious decision is to stick with the solution they already have in place. This is why delivery times can be slow and gross margins can be high on replacement parts. Historically, it has probably been the case that Breeze and UTC work harder to please an original equipment manufacturer than they do to please the helicopter operators. As we’ve mentioned before, Breeze’s CEO has said they plan to improve customer service and speed up delivery times. But, historically, once an operator is using a certain hoist they generally have to deal with slow delivery times and high prices on the parts they need.

Click here to subscribe or buy this issue.


Bruce Murison* contacted me at the start of June with an interesting proposition: He would open a dedicated account to trade the Acquirer’s Multiple All Investable Stocks Screen and post his strategy and results on the site. He thought knowing there was a public eye keeping him on the straight and narrow might assist with his discipline (the same reason I launched Greenbackd in 2008). He wondered if a real time, real money account tracking the acquirer’s multiple’s performance would be interesting to readers of the site. I of course leapt at the opportunity. Bruce hopes that his project might encourage outside the box thinking and maybe lead to others posting their strategies and ideas that could become an interactive community of users. Here begins Bruce’s first post in what I hope will be a long series:

I am dedicating a $25,000 real money account to trade stocks ranked favorably according to The Acquirers Multiple (TAM). Every stock will be chosen and traded according to these rules:

  1. For purposes of this plan, Qualifying Stock (“QS”) is defined as the stock on the All Investable Stock Screen (“Screen”) with the lowest Acquirer’s Multiple, after excluding stocks currently held in the portfolio.
  2. The fully invested portfolio will consist of ten QS and negligible cash.
  3. The initial portfolio will be constructed over the course of the first year by buying the new QS every 36 calendar days until fully invested.
  4. When any 36th day, measured from the date of the previous purchase, falls on a day U.S. markets are closed, the QS will be bought on the next trading day.
  5. Each stock will be reviewed shortly before the one year anniversary of its purchase. If its sale would result in a loss, sell just before the one year anniversary; if a gain, sell just after.
  6. Replace each stock sold with the current QS.
  7. If, however, the stock to be sold, would, if not already held, be the new QS, do not sell but hold for review again one year later.
  8. If a portfolio stock becomes the object of a takeover or merger that closes before the one year anniversary of its purchase, reinvest in the current QS as soon as the cash is received and / or any securities received in exchange are sold.
  9. Strive, at purchase, for equal dollar weightings of each stock, to the extent possible. However, no rebalancing trades will be made during a stock’s holding period.
  10. All trades will be market-on-close.
  11. No margin will be used.
  12. The performance benchmark is the total return of the Russell 3000 Index.

Read more.


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