Acquirer's multiple (EV/EBITDA) vs Magic Formula (EV/EBIT + ROC)

[dabuff]

For those of you who like buying baskets of cheap stocks, does anyone have any thoughts on using Greenblatt's Magic Formula  vs Tobias Carlisle's Acquirer's Multiple for such mechanical investing?

 

It seems that stripping out the ROC criterion from the Magic Formula actually improves returns due to reversion to the mean, according to Carlisle.

 

If you do mechanical investing, how big are your basket portfolios? Do you simply buy the cheapest stocks by EV/EBITDA/MF criteria without any further judgement?

[eclecticvalue]

Ev/EBITDA - That's what Private Equity professionals and Hedge funds use.

[dabuff]

Right. It just seems rather funny that one of the best metrics for valuation uses as input EBITDA, which Buffett and Klarman are wary of (Munger once even said that EBITDA = BS earnings).

 

[frommi]

Marsh_Gerda @ http://justadrone.blogspot.de tracks the magic formula since 2006, before you put any money into some kind of mechanical investing based on MF or EV/EBITDA i would read that blog.

 

If i would ever do this kind of investing, i would create a list of quality businesses i like to own (and know) and then rank them on EV/EBITDA or something else.

[Jurgis]

If i would ever do this kind of investing, i would create a list of quality businesses i like to own (and know) and then rank them on EV/EBITDA or something else.

 

And then it's not mechanical investing anymore, so you might as well do full-fledged analysis of these businesses before investing, no?

 

Edit: This shows how mechanical investing is as tough as any other kind of investing. People are tempted to fiddle with formulas, to change them because "they are not working", or to start pick and choosing companies from the mechanical screen.

 

Of course that happens with non-mechanical investing too. Buy-and-hold: tough to sit and do nothing. Valuation based buys-sells: tough to have discipline to buy and sell at specific valuation points. Qualitative/management based: tough to stay with management when they do something you don't like or they are underperforming for a stretch.

[violet_contamination]

Nate Tobik wrote a thoughtful piece on the topic..

 

http://www.oddballstocks.com/2013/01/thoughts-on-quantitative-value-investing.html

[frommi]

And then it's not mechanical investing anymore, so you might as well do full-fledged analysis of these businesses before investing, no?

 

Yes, there is probably is no easy way to riches. Nates blogpost says all there is to say about this topic.

[innerscorecard]

A sizable part of my portfolio is based on the strict, mechanical Magic Formula. Basically by-the-letter, according to Greenblatt's rules. Funnily enough, one of the things that convinced me to do it this way was Gray and Carlisle's writings. So their writings convinced me not to use either of their tweaks to the Magic Formula!

 

Marsh Gerda's blog is laudable for its honesty, but you can see how he always shoots himself in the foot by continually making little tweaks here and there in the Magic Formula. It would have been better if he hadn't done them.

[Hielko]

If the underlying idea is solid I would think that making little tweaks shouldn't be a problem. If there is a high variability in long-term outcomes with small changes in the underlying strategy all results are probably just random noise.

[frommi]

A sizable part of my portfolio is based on the strict, mechanical Magic Formula.

 

Do you have some performance numbers and how long are you doing it?

 

 

[innerscorecard]

Not so long. Just since some time last year. It happens to work pretty well with the way I think. I think the problem with small tweaks is that they tend to become big ones.