Deep Value -Why Activist Investors and Other Contrarians Battle for Control of Losing Corporations : [PDF Download]

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“The bigger the value premium, the better a given price-to-value ratio identifies undervalued and overvalued stocks. It’s a more robust test than simply measuring the performance of the undervalued stock. Again, both enterprise multiples stand out.

The EBIT variation of the enterprise multiple generated the largest average value premium at 7.5 percent annually, while the EBITDA variation earned 6.2 percent. Among the other historical priceto- value ratios, the enterprise value-to-free cash flow ratio generated the smallest spread, indicating that it did the worst job sorting undervalued and overvalued stocks.

The EBIT and EBITDA enterprise multiples still outperform after adjusting for volatility. Both had slightly higher volatility relative to the market, but this was predominantly upside volatility.

This lead both variations of the enterprise multiple to have the best volatility-adjusted returns. Empirically, the enterprise multiple—and Greenblatt’s EBIT variation, in particular, does the best job of identifying undervalued stocks.”

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