Most Shared Value Investing News – Week Ending March 3, 2012

Mar.03, 2012 in Financial News Leave a Comment

Here’s a list of the most shared articles posted on Value Investing News this past week:

  1. Berkshire Hathaway Inc. 2011 Annual Report
  2. Top 10 Hedge Funds By Net Gains Since Inception
  3. Jeremy Grantham’s 10 Investment Lessons
  4. Grantham: 10 Investment Lessons
  5. Dan Loeb’s Third Point Starts Apple (AAPL) Stake: Top Positions & Latest Exposures
  6. Beta of a Stock is a Meaningless Measure
  7. Notes on the 2011 Berkshire Hathaway Annual Report, Part 1
  8. Thinking about the Insurance Industry
  9. Price-To-Book Ratio (P/B Ratio) Backtest
  10. Eric Sprott’s Latest Commentary: 2012 is Year of the Central Bank

Where there any other great value investing articles that were published this past week but are missing from this list? If so, please share them in the comments section below.

Price-To-Book Ratio (P/B Ratio) Backtest

Mar.01, 2012 in Stock Fundamentals 3 Comments

The price-to-book ratio (P/B ratio) is a popular valuation ratio. It is calculated by taking the latest stock price and dividing it by book value per share.  Book value is simply the total assets found on the balance sheet minus  liabilities, which is referred to as common shareholder’s equity. To get book value per share all you have to do is divide book value by the number of shares outstanding.

Let’s see how well the P/B ratio performs. I used the data and backtesting tool provided by Portfolio123. This backtest uses the same filtered universe of stocks as my recent market capitalization backtest. I’ve designed the filtering criteria for this backtest specifically for individual investors and with a focus on enhancing data quality. The filters include the following criteria: Read the rest of this entry »

Returns by Market Capitalization Over the Past Decade

Feb.28, 2012 in Stock Fundamentals 1 Comment

Market capitalization is simply the total dollar value of all of a company’s outstanding shares of stock. It is often referred to as market cap for short. You can calculate market cap for a company by taking the current market price for a share of stock and multiplying it by the number of shares outstanding for that company. The size of a company is often measured by market capitalization and the media is routinely fascinated by which company currently has the highest market cap.

Stocks are often lumped into categories based on market cap. Those categories often include the following:

  • Mega Cap (> $100 billion)
  • Large Cap (>$10 billion)
  • Mid Cap ($2 to $10 billion)
  • Small Cap ($300 million to $2 billion)
  • Micro Cap (< $300 million)
  • Nano Cap (< $50 million)

These market cap size category definitions vary from source to source and can change over time. As a fat pitch value investor, I’m most interested in seeing if there is difference in returns for stocks based on market cap. Past studies have indicated that some market cap categories outperform other categories. Often small cap stocks are cited as generally outperforming large cap stocks. However, these market cap differences change over time and the performance differences may change with the business cycle.

I’m not one for really relying on past studies. I decided to do my own backtest. I used the data and backtesting tool provided by StockScreen123. This backtest will be the first one of a series of backtests that differ from my Richard Tortoriello inspired backtests. I’ve designed the filtering criteria for this backtest specifically for individual investors and with a focus on enhancing data quality. The filters include the following criteria:

  1. No OTC stocks. Stocks not traded on the New York Stock Exchange, NASDAQ, or American Stock Exchange markets are excluded. The quality of fundamental stock data for OTC can be somewhat lower and less timely that that for stocks traded on major exchanges.
  2. No ADRs. Fundamental data for foreign American Depositary Receipt can include errors due to currency exchange, different accounting standards, and share count.
  3. Exclude miscellaneous financial services industry. This is mainly to filter out closed-end funds.
  4. Liquidity test. The average daily total amount traded over the past 60 trading days must be larger than $100,000.  This amount was selected so that a $1 million dollar portfolio could hold 100 positions and that each new $10,000 position would not exceed 10 percent of a day’s trading volume. The liquidity test also ensures that the backtest has reliable market price information for any of the stocks that are being tested.
  5. Market Cap > $50 million. Nano cap stocks are excluded to help improve data quality. This filter also ensures that positions in a modest sized portfolio never exceed one percent of shares outstanding or the available float for a company.
  6. Price > $1. True penny stocks are excluded due to various information issues and manipulation of these stocks.

After these filters are applied, we are left with approximately 3,000 to 4,000 stocks. These are then ranked by the criteria being tested; in this case, we are testing market cap. The top 20 percent of stocks ranked by market cap is placed in the first quintile and the next 20 percent in the second quintile and so forth until we have five portfolios of stocks. The portfolios are rebalanced every 12-months and compounded annually to more realistically replicate what an individual investor might be expected to do to avoid higher short-term capital gains tax and trading costs. To help ensure that the test is not impacted by seasonal or statistical effects, the backtest is also started at four different points during the calendar year.  The results of the quarterly tests are used to calculate the average excess returns for each quintile. The results for the 10-year  market cap backtest are as follows:

Market Cap: Average Excess Returns vs. Universe

Market Capitalization: Rolling 3-Yr Periods Excess Returns vs. Universe

As you’d expect, the largest 20 percent of stocks underperformed the other stocks by 1.89 percent. The surprising result was the outperformance of the second quintile. The second quintile currently includes stocks with market caps between $4.2 billion and $1.5 billion. These are basically mid cap stocks. The CAGR of the second quintile from December 31, 2001 to January 1, 2012 was 8.48% and the annual average outperformance of the four seasonal starting points was 0.34%.

The one thing I didn’t expect was the underperformance of the bottom quintile, the micro cap stocks.  However, this underperformance might have more to do with the relatively short 10-year backtest. If you look at the rolling 3-Yr periods excess returns versus the universe chart, the red line represents the bottom quintile.  From 2003 to about the third quarter of 2005, the micro cap category actually outperformed the universe.  The micro caps really get hit during the financial crisis and that is the main reason they underperform in this backtest.

The micro cap category results provide a good reminder that past performance is no guarantee of future results.  My goal with this backtest and future backtests is only to identify potential spots to look for fatter pitches.

Do prefer stocks from a certain market cap category? If so, please share which category you prefer and why. I’m also interested in your feedback regarding the 6 filtering criteria I used for this backtest. I plan on using those filters for future backtests, so it’s important that I get your feedback now. Please share your thoughts in the comments section below.

Price to Current Fiscal Year Earnings Backtest

Feb.20, 2012 in Stock Fundamentals 1 Comment

Another widely used valuation ratio that Richard Tortoriello examined in his book Quantitative Strategies for Achieving Alpha is the P/E ratio. It is probably the most recognizable and used stock valuation metric. There are several variations on this popular fundamental ratio, including using trailing twelve-month earnings per share, one-year forward earnings per share estimate, and the use of enterprise value instead of market price. Tortoriello decided to present the backtest result for the P/E ratio that uses current fiscal year earnings, since he found it to have the most consistent performance.

Read the rest of this entry »

Current Best Values: Return on Enterprise Value

Jan.27, 2012 in Stock Research 1 Comment

The results for the Return on Enterprise Value backtest were very impressive, so I thought readers would be interested in seeing a list of the top 1% of stocks ranked based on Net Cash Flow / Enterprise Value.  Here are the current results: Read the rest of this entry »

Return on Enterprise Value (ROEV) Backtest

Jan.24, 2012 in Stock Fundamentals 8 Comments

Return on Enterprise Value (ROEV) is a stock valuation ratio that can be useful for comparing the values of different companies. It is simply net cash flow divided by enterprise value. Net cash flow is net profit plus amounts charged off for depreciation, depletion, and amortization.

I was unfamiliar with this stock fundamental until Ken Faulkenberry of AAAMP Blog left the following comment on my Enterprise Value to EBITDA Ratio Backtest post:

Great post; glad to read someone uses this strategy in this day of “passive management”. This kind of valuation of stocks needs much more attention!

Personally I prefer Net Cash Flow / Enterprise Value which would include interest expense. I have written an article titled “Best Stock Valuation Calculation to Value Company Shares is ROEV” for anyone interested.

I decided to backtest Net Cash Flow / Enterprise value and compare it to the excellent results of the EV / EBITDA Ratio backtest.

Read the rest of this entry »

Current Best Values: Enterprise Value to EBITDA Ratio

Jan.17, 2012 in Stock Research 5 Comments

Given that we recently backtested the highly effective Enterprise Value to EBITDA ratio that was presented in Quantitative Strategies for Achieving Alpha, I thought folks might be interested in seeing the current results for this screen. Here are the top 1% stocks ranked on EV/EBITDA: Read the rest of this entry »

Enterprise Value to EBITDA Ratio Backtest

Jan.13, 2012 in Stock Fundamentals 14 Comments

The EBITDA to enterprise value (EV) ratio is a widely used valuation multiple to assess the relative value of companies. It is calculated by simply taking earnings before interest, taxes, depreciation and amortization (EBITDA) and dividing by enterprise value (EV). Of course, you need to know the definitions of both of those terms to really be able to understand this stock fundamental.

EBITDA is equal to net income with interest, taxes, depreciation, and amortization added back into it. EBITDA is somewhat useful for analyzing and comparing profitability between companies and industries because it removes differences due to tax rates and eliminates the effects of financing and accounting decisions. However, many value investors shun this fundamental due to its past abuse during the tech bubble. Charlie Munger is quoted as saying, “I think that, every time you saw the word EBITDA [earnings], you should substitute the word “bullshit” earnings.” Read the rest of this entry »

Book Review: Quantitative Strategies for Achieving Alpha

Jan.10, 2012 in Book Reviews 5 Comments

Quantitative Strategies for Achieving AlphaOver the holidays, I read Quantitative Strategies for Achieving Alpha by Richard Tortoriello. I found this book to be very different than most of the books I’ve read on investing. Tortoriello spends a substantial portion of the book walking the reader though his process for evaluating various stock fundamentals. He then tests each of these fundamentals using twenty years of high quality backtesting data from the Standard & Poor’s Compustat Point in Time database. Unlike other books that discuss investment theory and qualitative analysis, this book is very empirical. The stock fundamentals Tortoriello analyzed include many value investor favorites. Based on that alone, I think many intermediate to advanced value investors could benefit from this book. Beginners might find this book a bit overwhelming.

Read the rest of this entry »

Closing Out 2011, Kicking Off 2012

Jan.03, 2012 in Model Portfolios 1 Comment

Happy new year fellow investors! I hope you enjoyed the holidays as much as I did. It was great spending time with my family this past week, taking a break from work, and reflecting on the future.

2011 was a challenging year, especially for fellow investors and website owners. The long hoped for economic recovery hasn’t really materialized yet. Web ad sales have been terrible and interest in stock market blogs was flat at best.

Thankfully, the portfolios I track for Fat Pitch Financials did pretty well in 2011.  The flagship Fat Pitch Financials Port that I track at Marketocracy returned 5.98% last year. Since inception, it is up 56.58% or 6.35% annualized. The Special Situations Real Money Portfolio had a rough year, but it was still able to return 7.14% in 2011. Since inception, the Special Situations Real Money Portfolio is 187.7% or 25.4% annualized! Finally, the Workouts model at Covestor recovered nicely in the last quarter of 2011, so it was able to return 9.51% in 2011. Since inception, it is up 7.07% or 6.01% annualized (Edit: Workout model numbers updated with end-of-year results). My hope that in 2012 I will start attracting some subscribers to the Workouts model now that it is starting to outperform the market.

I plan on kicking off 2012 with a return to fundamentals. I recently finished reading Quantitative Strategies for Achieving Alpha by Richard Tortoriello. My favorite investment tool, StockScreen123 also just upgraded its backtesting function to include dividends in returns, four new benchmarks that include dividends (total returns), and a new screening function for examining stock splits. I’m planning to combine what I learned in Tortoriello’s book with the new features of StockScreen123 to create a series of posts that examine how well the fundamental ratios most watched by value investors performed over the past decade. My end goal is to create a Ted Williams style strike zone chart that will show me when to swing for the fat pitch stocks in 2012.

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