I describe myself as a value investor. When I first started my investing career, I built my strategy around Benjamin Graham’s initial template for value investors, and it has evolved from there. Over the years the strategy has adapted from being a pure play deep value strategy to something different, what I like to call buckets, built around the same notion of buying undervalued equities.
There are three of these main buckets I have in my portfolio. First, there are the traditional deep value stocks; these are companies trading below book value and at appealing earnings multiples with room for intrinsic value growth. The second bucket is devoted to high-quality stocks, which also look undervalued. The one difference between this second bucket and the first bucket is that I’m prepared to pay a slightly higher price for better quality. The third and final bucket is the smallest and also the most speculative. Here I have the stocks that I believe can grow significantly and are undervalued based on future earnings potential.
All of the companies across all of the buckets have two traits in common: 1) a high insider ownership and 2) a strong cash balance and cash generation.
Time to index
I decided to move a significant portion of my portfolio into index funds because I no longer had the time to conduct the rigorous level of due diligence required to adequately invest in high-quality value stocks. After several months of research and observation of this strategy, I’m now planning to expand the part of my portfolio that’s not devoted to individually researched stocks. The reasons why I’ve decided to allocate such a large portion of my portfolio to an index fund is to help improve returns and lower the time spent managing investments. Buying an index fund isn’t the only way I could have accomplished this goal, and I am now going to expand my strategy to include another quantitative element.
A numbers game
One investing style that has always interested me is using a quant strategy to pick stocks with little or no fundamental analysis and rebalancing every year. Such strategies have been shown to produce results consistently and are used by asset managers all over Wall Street.
The reason why I want to incorporate such a strategy in my portfolio is to broaden my investment horizon, try to improve returns and conquer any investment emotional biases I might have. I’m planning to select 10 stocks all of which have strong balance sheets but EV/EBITDA ratios in the lowest decile of the market. According to four decades of data, EV/EBITDA is the most reliable indicator of value that goes on to produce the best returns. According to my initial research, three of the 10 stocks that fall within my criteria are trading at 52-week or all-time highs, which would usually put me off investing but because this experiment is entirely quantitative, I’m going to take the plunge and get over my emotional bias.
The point of including this quantitative strategy alongside my fundamental value positions and index funds is an attempt to improve my returns, broaden horizons and increase diversification while minimizing time spent researching opportunities. I spend a lot of time writing about studies on the best strategies to profit in the market, and while the data shows EV/EBITDA is the best metric, so far I’ve yet to base an investment of this. I will be running this element of the portfolio for six months and at the end of the period reviewing performance compared to the value picks and an index fund. If any portfolio shows strong over/underperformance, I’ll review the weightings.
As a successful investor you’ve got to be willing to branch out and broaden your horizons; this experiment is part of my attempt to do this. Three different strategies all based on evidence and experience. The results will speak for themselves – they may not be as positive as I would like, but I can be sure this experiment will produce some interesting results I can use to improve my understanding of investing because there’s no substitute for real life experience.
