I have been having discussions with Richard Beddard 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. That's not going to stop me in what I am about to do, though. I also take inspiration from Joel Greenblatt and his Magical Formula. I am a little skeptical of his formula, though, as people have reported results that are less than the returns that he claims to have. It is also too difficult to replicate his precise calculations, not least because he hasn't laid them out in precise detail.
Another source that I am taking inspiration from is Stingy Investor, who is doing exceptionally well with a Ben Graham formula. The portfolio has thrashed, and I do mean thrashed, the S&P500 over a decade, having returned 18.1% annually. Good enough for you? The formula is very restrictive, and tends to throw up very few stocks. I have decided to broaden and simplify their approach into just two basic criteria: balance sheet safety, and cheapness. Here are the exact criteria I used:
- Market cap > £200m - for adequate size and low spreads
- Z-score > 3 - the balance sheet safety measure
- PTBV (Price to Tangible Book Value) > 0 - I don't want any company with negative tangible equity
- PER > 0 - I want to ensure some earnings
- Operating margin > 0 - this just ensures that earnings aren't made positive by exceptional gains
I rank the results by ascending PTBV.
It is easy to run this screen using Sharelock Holmes. I then run through the results, from top to bottom, selecting 10 shares. I want to diversify by sector. Seeings as the results tend to be clustered in the same sectors, I allow only two companies per sector. I also apply some very lightweight rationalising to my selection. For example, I will allow two miners in, but not if they're both platinum miners; and I consider oil producers to be the same as miners. I have also excluded REITs, because they tend to trade on low book values anyway, and I think they are similar-ish to housebuilders. Similarly, I have lumped "construction and materials" in with housebuilders. One food producer that cropped up on my list was Asian Citrus (LON:ACHL) , which sells crops in Asia. It has a dual-listing on Hong Kong, which many readers might know is a giant red flag to me. Nevertheless, I have included it in the list. The next share on my screen is Anglo-Eastern Plantations (LON:AEP) , which develops in Indonesia and Malaysia. So I have given that one a miss, as it is too similar to ACHL.
I have not investigated the companies in any depth, and have not applied any insight as to how they are likely to perform, their relative merits, and so on. I have simply tried to diversify sectors and applied a minor amount of common sense.
With that in mind, here's the list I came up with:
Name Share Price Sector
- Asian Citrus (LON:ACHL) 59 - FOOD PRODUCERS
- Anglo Pacific (LON:APF) 328.7 - MINING
- Bovis Homes (LON:BVS) 441.6 - HOUSEBUILDERS
- Bellway (LON:BWY) 703.5 - HOUSEBUILDERS
- Eastern Platinum (LON:ELR) 61 - MINING
- Home Retail Group (LON:HOME) 157.9 - GENERAL RETAILERS
- Morrisons (LON:MRW) 300.5 - SUPERMARKETS
- Misys (LON:MSY) 413 - SOFTWARE
- Robert Wiseman Dairies (LON:RWD) 324.5 - FOOD PRODUCERS
- J Sainsbury (LON:SBRY) 327.5 - SUPERMARKETS
The prices (SP) quoted are the ask price in pence as of yesterday closing, obtained from Interactive Investor. The FTSE All Share stands at 3122. See you in a year's time.