A year ago, I wrote a post about value-based portfolios, whether they worked, and under what circumstances:
My view is that deeper value shares only provide truly superior performance, as a class, coming out of bear markets. I don’t think this is where we find the markets today, so I consider mechanical value-based strategies to be risky propositions at this point in time.
I chose 10 shares with market caps over 200m, z-score > 3, PTBV > 0, PER >0, operating margins >0. The results were ranked in ascending PTBV. The aim was as “safe and cheap”.
Here are the share price performances over a year: APF -23.0%, ACHL -39.8%, BWY +16.1%, BVS +7.0%, ELR -77.1%, HOME -47.6%, MSY -15.3%, MRW -10.4%, SBRY -5.1%. That’s an average performance of -21.7%. Over that time period, the ASX (All-share) returned -5.9%.
In a word: ouch! The portfolio vastly underperformed the index. So much for “safe and cheap”. I do claim a victory of sorts: that I was sceptical of value-based portfolios.
A little commentary: I did express concern over ACHL, as I have never thought it was an investable company. My scepticism was well-founded, as it turned out to be the second-worst performer. However, I included it anyway, because I wanted a mechanical portfolio. The best performers – and indeed the only performers – were the housebuilders (BVS and BWY). This is interesting, because the sentiment was very much against housebuilders at the time. Sentiment is still strongly against housebuilders. So there’s some word of caution here that negative sentiment does not necessarily equate to negative performance. I think the supermarkets acquitted themselves fairly well. Although MRW did underperform the index, SBRY was in-line. Quite surprising, given the fuss over supermarkets earlier this year.
For my selection this year, I’m going to adopt a different strategy in how I choose “safe and cheap”. It’s simply this:
- rank all the Footsie companies in descending yield
- reject all companies with betas >= 1
- Choose the top 6 in the list
- Avoid sector replication
I’m choosing 6 instead of 10 companies because it’s quicker, easier, and as we’ve seen, a larger portfolio doesn’t necessarily provide better protection.
Then there’s the issue of “beta”. I envisage a lot of distaste from the value-investing community on chosing this as a criteria. Most will consider it a meaningless measure of risk, whilst the more lenient might consider it a historical curiousity, rather than a predictive measure.
My own view is that, well, you know what, I think it might be a better measure of risk than many suppose. The market is actually really is telling you something.
I am reminded of a very insightful remark by Aswath Damodaran: a PE is a combination of risk-free rate, expected growth, and riskiness of the company. As value investors, we tend to lose sight of the fact that just because a company is on a low PE, it doesn’t mean it is cheap. As Peter Lynch would say, “buying cyclical stocks on low PEs is a proven way of losing money”.
On that basis, my share slections are:
BA. – Aero and defence
AZN – Pharma
VOD – Mobile Telecomms
NG. – utilities
MKS – general retailer
SBRY – food and drug retailers
I actually think this will turn out to be a sensible selection, and has a good chance of outperforming the index, except in the case where there is a strong surge in share prices. Then it will likely underperform.
See you in a year.