International Evidence for our favorite Value metric: Enterprise Multiples
The Enterprise Multiple Investment Strategy: International Evidence
- Walkshäusl and Lobe
- A version of the paper can be found here.
- Want a summary of academic papers with alpha? Check out our Academic Research Recap Category.
The enterprise multiple (EM) predicts the cross section of international returns. The return predictability of EM is similarly pronounced in developed and emerging markets and likewise strong among small and large firms. An international portfolio of low-EM firms outperforms a portfolio of high-EM firms by about 1% per month. The EM value premium is individually significant for the majority of countries, remains largely unexplained by existing asset pricing models, is robust after controlling for comovement with the respective U.S. premium, and is highly persistent for up to 5 years after portfolio formation, making it a promising strategy for investors.
Jack and I started work on a paper in 2010 that highlighted the results of a study we conducted to identify the top valuation metric. The results? EBITDA/TEV came out on top. This metric didn’t win all the time, but it seemed to be the most robust over the long-haul. Next, we wrote an entire book dedicated to quantitative value and once again found that enterprise multiples/yields performed the best (specifically EBIT/TEV), and they could be improved through the addition of quality metrics. Finally, we wrote a paper that explored all the value investing metrics posted on the AAII website and found that none of them can reliably beat EBIT/TEV. Sheesh…I’m getting tired just thinking about all the work we’ve done on value metrics…
…But we aren’t the only ones to identify the historical benefits to buying cheap companies based on enterprise multiples. For example, Loughran and Wellman published a paper in the JFQA in 2011, and it it they claim that enterprise multiples are a “strong determinant of stock returns.” And now we have the paper under discussion, which highlights what we’ve known internally for some time now–enterprise multiples have worked in international markets.
This paper examines 40 non-U.S. countries from 1981 to 2010. The sample includes 22 developed markets and 18 emerging markets. Using the same method as Fama-French, the authors create 6 value-weighted portfolios formed on size and EM. Then they compare the performances of low EM portfolios, high EM portfolios and EMD portfolios (enterprise multiple difference, i.e., low EM portfolios-high EM portfolios, similar to Fama-French’s HML metric)
- Enterprise value = market value of equity + debt + preferred stock – cash and short-term investments
- Enterprise Multiple (EM) = EV/EBITDA
A few key points from the paper:
- An international portfolio of low-EM firms outperforms a portfolio of high-EM firms by 0.95% per month, with a t-stat of 6.97. What’s more, international EM premiums are 2 times higher than the corresponding U.S. EM premiums studied by Loughran and Wellman (2011).
- The EM premiums are significantly positive in all 40 non-US countries. Especially, 18 out of the 22 developed markets have significant t-stat (>2) and 8 out of 18 emerging markets have significant t-stat (>2).
- When they rank country EM premiums from high to low, the top 5 developed countries are: Portugal, Australia, Switzerland, Sweden and Austria, and the top 5 emerging markets are: Pakistan, Brazil, Peru, Argentina and Thailand.
Clearly, the enterprise multiple approach to value investing works well in non-US markets, at least it has done so historically. Investors who believe these results might continue, who want international diversification, and believe in the value anomaly, should look for international value strategies based on enterprise multiples. We have offerings exclusively focused on these metrics, but we encourage readers to study all offerings available.
Here is the visual depiction of the results posted above in the table.
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Definitions of common statistics used in our analysis are available here (towards the bottom)