Intelligent Investing, an update

It’s been around a year since I recommitted to Intelligent Investing.  So, how successful have we been?  Here are the results.

Buy Date Sell Date
Teck Resources

$27.03

25-Apr -13

$27.23

27-Dec -13

Power Corp

$26.20

25-Apr -13

$32.10

27-Dec -13

Intact

$58.60

13-May -13

$69.00

27-Dec -13

Dorel

$41.01

17-May -13

$40.50

Still Owned
Finning

$22.89

29-May -13

$23.56

15-Oct -13

Xerox

$8.90

31-May -13

$9.80

12-Jul -13

Laurentian

$44.30

31-May -13

$47.15

Still Owned
Berkshire

$112.48

29-Aug -13

$128.20

28-Apr -14

Cogeco

$48.25

27-Dec -13

$60.40

28-Apr -14

JPMorgan

$58.20

2-Jan -14

$55.58

Still Owned

The average advance was 9.4%.  The average duration of ownership was 200 days, meaning that I turned over the portfolio around 1.75 times per annum.  This means that that the annual return was around 16.5%.  The TSX returned around 17% in the same period, while the S&P500 returned around 16%.  So, my returns are average.

None of these figures include dividends.

A New Asset Allocation

I have decided to get back to more fundamental value investing.  Accordingly I have reviewed my Investment Policy and have decided upon a new Asset Allocation.

My basic stance is that I should set the percentage of bonds to be equal to my age, which is 42.  Current highish market levels, especially in the US, indicate that I should lean slightly more towards bonds, but low bond yields indicate that I should lean towards stocks, and dividend yields also suggest a bias towards stocks. On balance I have decided to set my bond component to 33.5%. This is halfway between Benjamin Graham’s recommended minimum of 25% and the age-based 42%.

So, my new Asset Allocation will be 33.5% bonds and 66.5% stocks.  Also, I will not deploy all of my stock funds (the 66.5%) immediately.  I will wait until opportunities arise that offer a sufficient margin of safety, such as Power Corp and Teck Resources.  Accordingly, I expect to hold a considerable amount of cash where I cannot find value stocks to invest in.

Getting back to Intelligent Investing

I began this blog in April 2011 after reading The Intelligent Investor by Benjamin Graham.  I just re-read it and realized how far from his teachings I have strayed.  This is pretty normal, in fact Graham describes the psychology of the typical investor and I have fallen into some of the bad habits that he prescribed against (e.g., buying gold and speculation, which have both cost me money in recent weeks).  It’s time to get back onto the right path and follow Graham’s advice.  Accordingly I am recommitting to my original Investment Policy, which was written with Graham’s teachings in mind.

My Investment Policy is:

(1) I am an investor. I buy assets that are well priced based upon their inherent value (e.g., their dividends and prospects for dividend growth, and their earnings and prospects for earnings growth).

(2) I will invest in stocks and bonds of well known companies only (no speculative companies, no real estate, no gold).

(3) I will keep between 25% and 75% of my portfolio’s value in stocks and between 25% and 75% in bonds, depending upon my assessment of the likely return from the stock market versus that from bonds at the time.

(4) I will buy or hold stocks based upon two selection criteria:

Dividend: the company must pay a dividend, the higher the better; and

Return on Investment: the company must be priced such that the likely annual return is above 10%, with a 10% margin of safety (using an IRR calculation).

These two criteria are mandatory, but I may apply additional criteria to screen and select stocks. For example, I will not consider a stock with a PE Ratio above 20 and I generally look for stocks with a PE Ratio of 17 or less. I also look at the PEG Ratio.

(5) I am not a speculator, meaning that I do not buy assets based solely upon recent price advances in the hope that I will find a greater fool to sell them to later.

(6) I will not invest on margin as this is speculation.

But, we remember that Graham said:

“We are thus led to the following logical if disconcerting conclusion: To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street.”.

So how is my policy different from those on Wall Street? Well, I have never worked on Wall Street, but I know that they have one fatal flaw: impatience. Investment banks and money managers have customers who crave continuous returns. This is especially true of publicly traded investment banks, who are beholden to analysts from other banks and to quarterly reports. Brokerages, who are paid by the trade, are also keen to have investors turn over their portfolios more than is necessary. I feel no such pressures. As another great investor, Warren Buffet, said:

“The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!'”

(7) I will be patient and will hold a good value stock or bond that has not yet paid off.

Adopting an Investment Process

My Investment Process has been relatively ad hoc.  I have made asset allocation changes when I feel like making them.  Mostly, these decisions have been bad calls (e.g. moving from stocks to bonds in an attempt to time the market) but some have been good calls (e.g. going to cash in late March 2012).  I think I need a little more discipline so I have developed a new, formalized investing process.

I use a three level Investment Process.

LEVEL 1: ASSET ALLOCATION

There are four main assets classes in which I invest:

  • Stocks;
  • Bonds;
  • Cash; and
  • Commodities, such as gold.

Asset allocation is the act of deciding how much money, as a percentage of my total portfolio’s value, to invest in each asset class.

Once per quarter I will make my asset allocation decision based upon:

  • My Investment Policy;
  • My investing objectives (e.g. when will I need to withdraw the money?); and
  • Long-term market trends (e.g. major stock and bond fundamentals and technicals).

LEVEL 2: CORE POSITIONS

There are thousands of publicly traded stocks in North America, and thousands more in other regions of the world. Establishing core positions is the act of picking stocks in which to invest.

Once per month I will make identify my core positions based upon:

There is no upper or lower limit to the number of core positions, but keeping only a handful (5 to 10) of stocks minimizes trading fees while providing some diversification, and keeping the number low allows me to spend adequate time on their management.

LEVEL 3: TRADING AROUND

Once I have established my core positions I will trade around them: buy when they fall and sell when they rise (buy low and sell high).  This allows me to maximize the profit from my core positions.  The method is simple.

  • When a stock falls X% from the price at which I last traded I will buy $Y worth
  • When a stock rises X% from the price at which I last traded I will sell $Y worth

Every day I will monitor prices of my core positions and trade based upon:

  • My Asset Allocation decision, which tells me how much I can invest in stocks in total; and
  • The rise and fall of prices of my core positions.

Raising Cash – Sell in May and Go Away

In the past two years the market has performed well in the first three months of the year, and poorly in the summer. This is referred to as sell in May and go away. I discussed this in May 2011, but did not act upon it. In the first 3 months of 2012 we have seen the TSX rise by 3.8% and the DOW by 7.6%. These are heathy gains.

In both 2010 and 2011 the market turned down in mid to late April. I want to reduce my exposure now by selling stocks and raising cash. So, which stocks should I sell?

I began my assessment with two basic principles (based upon my investment policy):

  • Fundamentals: I assessed earnings and earning growth (based upon analyst estimates for 2012-2014), dividend yield and coverage, PE Ratio, PEG Ratio and the Gordon Return.
  • Diversification: I don’t want to hold too many stocks in one sector, e.g. Finance (Banking and Insurance), Energy (Oil and Pipeline), Telco, etc.

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Assessment of Energy Stocks:

  • Enerplus looks good. Dividend yield is strong at 9.6% (with coverage of 141%). HOLD
  • Canadian Oil Sands looks OK, but earnings growth is quite low (less than 6%) and the dividend is smaller than Enerplus’ dividend. HOLD
  • TransCanada has marginal earnings growth of around 7%, a high PE Ratio of 18.2, and a high PEG Ratio of 2.6. It looks overpriced. SELL

Assessment of Financial Stocks:

  • PowerCorp has great growth of around 12%, a decent dividend of 4.4% and a PEG under 0.9. It looks good. HOLD
  • Sun Life has low earnings growth of 5%, and a PEG of 1.8. Power is better in every measure. SELL
  • Royal Bank has a low dividend (under 4%, but with excellent coverage over 200% – needs to pay out more), marginal growth around 7%, and a high PEG of 1.6. SELL

Assessment of Telcos:

  • Telus has decent growth of over 9% and the other fundamentals are good (PEG is a bit high). HOLD
  • BCE has low growth of under 4% and a PEG of 3.3, which is highest in the portfolio. SELL

Other Stocks:

  • Shaw is another low growth (5%) and high PEG (2.38) stock, like BCE. It will lose revenue as people switch from cable TV to internet TV (e.g., Netflix, AppleTV, other internet TV services) but should compensate with its cable-based high-speed internet services and telephone. HOLD
  • TransAlta is the only stock with a dividend coverage of under 100% (it’s 95%) but it has decent earnings growth of 9%. Price is down recently, making it good value at this point. HOLD
  • Apple is scary due to high price increase, but fundamentals are good: 14% growth, PEG under 1, and a dividend announced. HOLD but watch for price to fall back into long-term channel.

Other assets:

  • Gold is around 5.7% of the portfolio. This is fine. HOLD

After discussion with my financial advisor I decided to sell TransCanada Pipeline, Royal Bank, Sun Life and BCE.

  • Sell SLF.TO @ $23.78
  • Sell RY.TO @ $58.13
  • Sell BCE.TO @ $40.00
  • Sell TRP.TO @ $43.00

Note: Three of these four sell orders were processed on 29th March. The TRP order did not process until 2nd April (it was a limit order). So, TRP appears in the March month-end holdings.

I also decided to increase my holdings of TransAlta. The business is very stable and the dividend yield is over 6%, making this a better place to park my cash than in cash. This purchase also happened after the month end.

  • Buy TA.TO @ $18.45

The net result of these trades is that my asset allocation will be:

  • 25% cash
  • 30% bonds
  • 6% gold
  • 39% stocks

POSTMORTEM

Writing one month later, on 27th April 2012, this trade has seen mixed results. Since selling on 29th March the TSX (^GSPTSE) has gone down 1.5%, so my call was good.

But the stocks I sold are up 0.2% on average, so my call was bad?  Let’s wait to see how things go over the summer before we make a final judgement.

Ticker Sell price Current price Change
TRP.TO $43 $43.19 0.44%
SLF.TO $23.78 $24.36 2.44%
BCE.TO $40 $39.93 -0.18%
RY.TO $58.13 $57.03 -1.89%
Average 0.20%

I also bought more TransAlta (TA.TO) stock, which is down 12% during the month. This was a bad call!  Very candidly, I did not want to buy more TransAlta but was persuaded to do so by my financial adviser.  I need to listen to my intuition more, and push back.

UPDATE

Writing today, 28th May, the decision to raise cash is looking better and better.  North American markets continue lower on European Debt worries.  The stocks I sold are now down an average of 6.34%, led by financials.

Ticker Sell price Current price Change
TRP.TO $43 42.01 -2.30%
SLF.TO $23.78 21.15 -11.06%
BCE.TO $40 40.5 1.25%
RY.TO $58.13 50.43 -13.25%
Average -6.34%

UPDATE

Writing today, 10th July, this decision is still looking good.  The stocks are still down an average of 2.22% and I think there could be more trouble ahead (August was horrible last year).

Ticker Sell price Current price Change
TRP.TO $43 43.34 0.79%
SLF.TO $23.78 22.14 -6.90%
BCE.TO $40 42.64 6.60%
RY.TO $58.13 52.69 -9.36%
-2.22%

Investment Policy Update – Can Hold Up To 10% Gold

My investment policy is based upon the principles that Benjamin Graham expressed in his book The Intelligent Investor. My Investment Policy is:

(1) I am an investor. I buy assets that are well priced based upon their inherent value (e.g., their dividends and prospects for dividend growth, and their earnings and prospects for earnings growth).

(2) I will invest in stocks and bonds of well known companies only (no speculative companies). I will invest in gold, but will keep gold to a maximum of 10% of my portfolio. This is a deviation from Benjamin Graham’s advice, but it is generally accepted that this was the one rare occasion on which Mr. Graham was incorrect.

(3) I will keep between 25% and 75% of my portfolio’s value in stocks and between 25% and 75% in bonds, depending upon my assessment of the likely return from the stock market versus that from bonds at the time.

(4) I will buy or hold stocks based upon two selection criteria:

  • Dividend: the company must pay a dividend, the higher the better; and
  • Return on Investment: the company must be priced such that the likely annual return is above 10%, with a 10% margin of safety (using an IRR calculation).

These two criteria are mandatory, but I may apply additional criteria to screen and select stocks. For example, I will not consider a stock with a PE Ratio above 20 and I generally look for stocks with a PE Ratio of 17 or less. I also look at the PEG Ratio.

(5) I am not a speculator, meaning that I do not buy assets based solely upon recent price advances in the hope that I will find a greater fool to sell them to later.

(6) I will not invest on margin as this is speculation.

But, we remember that Graham said:

“We are thus led to the following logical if disconcerting conclusion: To enjoy a reasonable chance for continued better than average results, the investor must follow policies which are (1) inherently sound and promising, and (2) not popular on Wall Street.”.

So how is my policy different from those on Wall Street? Well, I have never worked on Wall Street, but I know that they have one fatal flaw: impatience. Investment banks and money managers have customers who crave continuous returns. This is especially true of publicly traded investment banks, who are beholden to analysts from other banks and to quarterly reports. Brokerages, who are paid by the trade, are also keen to have investors turn over their portfolios more than is necessary. I feel no such pressures. As another great investor, Warren Buffet, said:

“The stock market is a no-called-strike game. You don’t have to swing at everything – you can wait for your pitch. The problem when you’re a money manager is that your fans keep yelling, ‘Swing, you bum!'”

(7) I will be patient and will hold a good value stock or bond that has not yet paid off.

Exiting Telus, Entering Gold

After a routine scan of my holdings is see that Telus (T.TO) has fallen below my mandatory screening criteria of: 10% return on investment with a margin of safety of 10%; and providing a dividend. My analysis of Telus shows that the return I can expect on the stock is only around 9.5% at the current price (see chart below). I have owned the stock for almost 2 years and have seen the price run up by over 53%. I have also received an annual dividend yield of around 4%. It’s been a great investment but it’s time to take the money and run.

  • SELL Telus (T.TO) @ $54.21

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This gives me an opportunity to add gold to the portfolio. More specificaly, I’m looking at the Sprott Physical Gold Trust (PHY-U.TO), which owns physical gold bullion held in the Canadian mint. This will give me a gold holding of around 6% of the overall portfolio.

  • BUY Sprott Physical Gold Trust (PHY-U.TO) @ US$13.46

My investment policy does not address gold, only stocks and bonds. So what does Benjamin Graham say about gold?

“The near-complete failure of gold to protect against a loss in the purchasing power of the dollar must cast grave doubt on the ability of the ordinary investor to protect himself against inflation by putting his money in ‘things'” – Benjamin Graham

In his commentary, Jason Zweig notes that this is one area where Benjamin Graham is commonly thought to be mistaken, and that gold has handily out-paced inflation in the years after Graham wrote his assessment.

I will limit my gold holdings to 10% of the overall portfolio.

POSTMORTEM

One month after this trade, on 7th August 2011, this looks like a very good call. Telus is down 8% and the Sprott Physical Gold Trust is up 8%. This chart (below) represents pretty much the ideal result of a smart trade.

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