• Prior Management Behavior & Outcomes
  • Momentum, Credit Quality & Size, Helping Identify Future Outperformers
  • Putting It All Together: Stock Selection

Prior Management Behavior & Outcomes

As explained in Part I of Activism Lite, we believe that the correlation of debt reduction with high excess returns creates a credible construct for investors to pursue with corporate management. This combination seemed particularly effective when paired with valuation as defined by FCF/EV. Our findings show that ultimately a company’s willingness to pay down debt may signal confidence in the sustainability of profits. When corporate management at high-debt firms create narratives infused with earnings growth based on synergy-rich acquisitions or product expansions, investors may be wise to consider the potential benefits of debt reduction instead.

While we believe that simply working in the least expensive component of the FCF/EV universe among high-debt companies and attempting to find stable cash flows and friendly management is an excellent idea, we decided to try shrinking the universe of stocks while improving efficacy. We began the research process with the idea that firms that had reduced (or added) debt in the prior year might be an excellent signal as to what their managements intended to do in the current year. Our analysis did not disappoint.

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In Fig. 1 below, we show the distribution of firms based on their prior-year’s change in debt. Firms that reduced debt in the prior year were much more likely to reduce debt again (ending up in tercile one), while firms that added the most debt in the prior year were far more likely to add debt again.

Figure 1 – Companies that Pay Down Debt Are More Likely to Do So Again

  1. As a reminder for our Financial Advisors: our models are available on a continuous basis, and most have been in production for over a decade.  If you are looking for simple, concentrated, low turnover, and tax efficient model portfolios we would like to talk with you.  KCR also offers a wide range of easy-to-use but sophisticated tools.  Our toolkits can help identify mispriced stocks with the best and worst risk/reward characteristics, estimate a stock’s duration and warn you when a company is engaging in low-quality accounting. Over the last 12 years, KCR has built and offers time-tested and class-leading products built by experienced and proven money managers for fixed to low prices.
  2. Kailash Capital’s sister company, L2 Asset Management, runs market neutral, long/short, large-cap, and mid-cap long-only portfolios with a value and quality bias.  L2 employs a highly disciplined investment process characterized by moderate concentration, low turnover, high tax efficiency, and low fees. While nobody can predict the future, we believe the recent resurgence in risk-adjusted returns seen across all products is the beginning of what may be a long period where speculation is punished, and prudence and patience rewarded.
The topics discussed in this article are aimed at seasoned professionals, as such, we have included some extra for anyone seeking out more information related to the topics above.


The information, data, analyses, and opinions presented herein (a) do not constitute investment advice, (b) are provided solely for informational purposes and therefore are not, individually or collectively, an offer to buy or sell a security, (c) are not warranted to be correct, complete or accurate, and (d) are subject to change without notice. Kailash Capital, LLC and its affiliates (collectively, “Kailash Capital”) shall not be responsible for any trading decisions, damages or other losses resulting from, or related to, the information, data, analyses or opinions or their use. The information herein may not be reproduced or retransmitted in any manner without the prior written consent of Kailash Capital. In preparing the information, data, analyses, and opinions presented herein, Kailash Capital has obtained data, statistics, and information from sources it believes to be reliable. Kailash Capital, however, does not perform an audit or seeks independent verification of any of the data, statistics, and information it receives. Kailash Capital and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only and is not intended to provide, and should not be relied on for tax, legal, or accounting advice. You should consult your tax, legal, and accounting advisors before engaging in any transaction. © 2021 Kailash Capital, LLC – All rights reserved.

Nothing herein shall limit or restrict the right of affiliates of Kailash Capital, LLC to perform investment management or advisory services for any other persons or entities. Furthermore, nothing herein shall limit or restrict affiliates of Kailash Capital, LLC from buying, selling or trading securities or other investments for their own accounts or for the accounts of their clients. Affiliates of Kailash Capital, LLC may at any time have, acquire, increase, decrease or dispose of the securities or other investments referenced in this publication. Kailash Capital, LLC shall have no obligation to recommend securities or investments in this publication as result of its affiliates’ investment activities for their own accounts or for the accounts of their clients.

February 9, 2013 |

Categories: White Papers

February 9, 2013

Categories: White Papers

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