Greenbackd

Deep value investing is a powerful way to beat the market, but deep value stocks are an endangered species in the U.S.

I was recently talking with Tobias Carlisle, author of Deep Value: Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations, about what constitutes a deep value stock. To find these stocks, Tobias prefers to use the “takeover” multiple. One version of the takeover multiple is the ratio of EBITDA (earnings before interest, taxes, depreciation and amortization) to enterprise value (market value of equity plus book value of debt minus cash).

This is a great multiple for stock selection. Like to price-to-earnings ratio, it helps you find unloved companies, but it also penalizes stocks for having too much debt (more debt = worse ratio, ceteris paribus). If all you did was buy the 10% of stocks with the cheapest EBITDA/EV ratios on an annual basis, you’d have outperformed the market by more than 5% annually over the past five decades.

I asked Tobias what he considers a very cheap multiple EV/EBITDA multiple, and we agreed that somewhere below 5x indicates a cheap stock, while a multiple of less than 3x indicates very deep value. So here is the problem: today, we face what is perhaps the most difficult environment for deep value investing in history.  Just 3.2% of non-financial, U.S. companies with a market cap of at least $200MM trade at an EV/EBITDA multiple below 5x.  That is just off June’s all-time low of 2.9%.