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.
December 17th, 2009 at 7:34 am
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
December 17th, 2009 at 8:51 am
“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.
December 17th, 2009 at 8:53 am
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.
December 17th, 2009 at 3:15 pm
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.
December 17th, 2009 at 9:29 pm
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.
December 18th, 2009 at 12:31 am
@ 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.
December 18th, 2009 at 4:13 am
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)
December 19th, 2009 at 12:23 am
Have you back tested a strategy like this?
December 19th, 2009 at 2:04 am
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.
December 19th, 2009 at 3:09 pm
@ 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.
December 21st, 2009 at 7:34 pm
AIRT specifically seems interesting at first look. I’ve been looking at BOLT too
Will dig into AIRT it further.
December 28th, 2009 at 2:14 pm
Jae,
How can I find out what are your current holdings?
TIA for your valued reply!
TC