OSV Auto Investing Paper Portfolio

December 17th, 2009

Passive Investing with Automated Portfolio
Why am I doing this?
How it Will Work
Auto Portfolio Expected Outcome

Passive Investing with Automated Portfolio

I don’t know about you, but over the past couple of months, things have been extraordinarily busy. My usual 1-2 company analysis per week has now become 1-2 stock analysis per month.

So with 2010 just around the corner, I wanted to try something for next year.

Something that will resonate with many folks out there, especially for those who

have an interest in investing but can’t dedicate the time
have a 401k that they would like manage on their own
prefer passive investing
want an auto portfolio but not a mutual fund

My idea is to track the progress of a passive investing portfolio where stocks are added whenever all three of my intrinsic value calculation methods is greater than the market price with a reasonable margin of safety.

Margin of safety doesn’t have to be 50% which is my personal strict requirement but the safety margin should be at least greater than 10%.

Why am I doing this?

Don’t misunderstand that I am advocating an automatic portfolio or passive investing. The reason for this is that if you’re a regular here at OSV, you’d know that I screen and filter through literally hundreds of companies each year.

Even now, trying to go through 200 companies is time consuming and in the process, I often miss a few real gems due to my haste. So I want to know whether a group of undervalued stocks that I deem undervalued will beat the market without me having to do so much research.

Call it another version of Joel Greenblatt’s Magic Formula, except I base my decision not on the earnings yield, but on my ability to calculate and apply a realistic growth rate, discount rate and few other factors to calculate the intrinsic value.

How it Will Work

Basically this is how it will work.

Throughout the year, use the investment spreadsheet to go through companies
Apply and adjust numbers to get the intrinsic value based on discounted cash flow valuation, Graham formula valuation and EPV
Quickly run through the financial statements to make sure there are no serious problems in the company (nothing too detailed)
If all three intrinsic value calculations are higher than the market price add it to the OSV paper portfolio
All positions will be $1000
Positions are sold if it reaches intrinsic value

The only condition is that the company is not a net net, distressed opportunity or special situation. This portfolio is suited more for passive investing and auto portfolios.

Check out the few companies that are likely to make it to the portfolio highlighted in magenta below. Click to enlarge image.

Auto Portfolio Expected Outcome

Assuming you at least know how to adjust variables to calculate the intrinsic value, I expect that buying undervalued companies should beat the market.

I’ll update you with a monthly progress status and hopefully, things will look good.

Are your stocks cheap or overvalued? Check with the stock valuation spreadsheets

- Tyler

Hi Jae, Keep up the good work.

i have been using a 15% discount rate in my DCF as i want 15% annual returns. I found Cash Converters which i bought so far up 25%, and i bought Telstra with a 12% discount rate so far its up almost 10%.

Thanks

- ted

“i have been using a 15% discount rate in my DCF as i want 15% annual returns”

this is simplistic, and not the right way to think about discount rates.

expanding on that logic, i think i will use a 1000% discount rate as i want 1000% returns.

also, what about margin of safety here? i dunno, i’m not a huge fan of using all 3 like this together, i think usually it’s more appropriate to pick one or two and use those to determine the price, then buy if there is an adequate MOS.

- Jim

Ted,

Simplicity, according to Einstein, is the highest order of intelligence. Choosing a 15% discount rate because that is how much of a return you are seeking on an annual basis is logical and a correct way of approaching a discount method. Being ‘precise’ has nothing to do with value investing. As Ben Graham often said, it is possible to determine whether someone is overweight without the need of a scale. To simply look at them is suffice.

- peekay

Nice work Jae.. One qs .. which one you’ll take as the Intrinsic Value .. for selling the stock i.e. from EPV, Graham’s or DCF … or an avg of the three? Thanks.

- Jae Jun

@ Tyler,
Well done on your profitable investment. Doing good at such a young age. I remember visiting cash converters so many times trying to pick up bargains, but never found one…

@ Ted,
I’m not going to just blindly add it if all 3 are green but the way I use it, if all 3 valuations is less than the market price, I’m pretty confident it is cheap unless something big and unpredictable happens.
Discount rate, I’m thinking at least 25% for 2 of them.

@ Jim,
Thanks for your comment Jim.

@ peekay,
hey I didn’t think about that
But there will be a low and high valuation so anywhere in between depending on how I think the market is acting. If it is volatile, I’ll just sell at the lower intrinsic value but if the market is fairly steady, I wouldn’t mind selling it at the midway point.

Thanks Jae, i think a problem with DCF for me is working out the owners earnings. Like For JBHifi i wrote a letter to a fairly well known value investor here this is it:

Operational Earnings = 145
Less
Capital Expenditure = 44
Total = 101
Plus
Depreciation On Fixed Assets = 19
Less
Tax = 41

Total = 79 Mil

Revenue = 2300
COGS = 1800
Less A few Other Things (Pg 53 Of Annual Report)
Total = 225
Less
Tax = 41
Cap. Expenditure = 44

Total = 140
Plus
Dep. On Fixed Assets = 19

Total = 159Mil

Shares Oustanding = 107 Mil

This is Is Either $1.48 or $0.74 Per Share.

Do You Perhaps Know Their Owners Earnings?
http://www.asx.com.au/asxpdf/20090911/pdf/31kp9589sd444g.pdf (JBH Annual Report)

- Ankit Gupta

Have you back tested a strategy like this?

- Fabrice

As I said to Jae by email, you may also be interrested by this “screener”:

http://www.investisseurheureux.com/screener/

based on OSV Excel Sheet. Datas are updated each week.

@ Tyler,

Check out Buffett’s 1986 letter right at the end for owner earnings definition.
http://www.berkshirehathaway.com/letters/1986.html

And read this post as well
http://www.oldschoolvalue.com/valuation-methods/working-capital-free-cash-flow-fcf/

@ Ankit,
No back test. Takes too much time. Easier to just do it and see

@ Fabrice,
Great work Fabrice.

- Mechanonuke

AIRT specifically seems interesting at first look. I’ve been looking at BOLT too

Will dig into AIRT it further.

- T. Cougar

Jae,

How can I find out what are your current holdings?

TIA for your valued reply!

- Bob

You need to back test this. Portfolio123.com will allow this to be done. Why don’t you post the results here. Obviously if strategy has not worked on past it is unlikely to do so again.

@ Bob,
Can’t be backtested I’m afraid. There is no way to backtest DCF or EPV and reproduction value with any degree of accuracy.

OSV Auto Investing Paper Portfolio

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