Tin Cup Questions

Cover Story, by Mark Robertson, Managing Partner June 1st, 2005

We've invited respected investment educator Dan Hess to ask a set of important questions on behalf of our subscribers.

In last month’s issue, we introduced our “Tin Cup” model portfolio. As I shared last month, this model portfolio ranks as one of the most exciting and intriguing things I’ve seen in my years of investing research. Many of you have expressed interest and have questions. You should have questions. We invited respected investment educator Dan Hess to ask a set of important questions on behalf of all of you.

13.9 Years to $1,000,000?

As incredible as that sum might seem, the Tin Cup model portfolio was launched on 12/31/94. The monthly deposits match the maximums allowed under 401(k) plans, starting with an annual limit of $9240 for 1995 and ending with the limit of $14,000 under current guidelines. The result (so far) is $109,000 invested over a little more than ten years. The current value of the portfolio is $571,141 — an annualized total return of 30.0 percent.

IF the portfolio achieves an annual return of 17.7% (the current overall projected annual return, or PAR, of the portfolio) it will reach $1,000,000 on November 11, 2008, 13.9 years after inception.

Continuing the Exploration

Dan Hess is an individual investor, lives in North Carolina and serves as a director on NAIC’s Central North Carolina Chapter. Dan is a long-time and respected contributor in a number of online investing communities. In his words, “I admit that I am still learning after investing for only 35 years.” If you have any questions, write to Dan at danhess@nc.rr.com.

Dan Hess: These are pretty impressive results. I found last month’s introduction of “Tin Cup” to be most interesting and it definitely made me want to search for how this was accomplished.

Mark Robertson: Thanks, Dan. Yes, the results are compelling and intriguing. I hope that we can learn a great deal from the case study and more importantly, apply what we learn to effective portfolio management.Dan: In the Rules of Engagement section, it was not clear if you had first studied the results and prepared a system and then went back and developed a portfolio following these rules. i.e. Did this involve “data mining”?

Mark: No, not at all. In fact, just the opposite. Data mining is an attempt to define a method using a set of empirical results. Tin Cup was built (starting in January 1995) by using the same methods of determining PAR and quality that we’ve been using at Manifest Investing. In other words, PAR and quality were determined for the VL universe of stocks in January 1995 and portfolio decisions were made on the basis of those evaluations. The process was simply repeated for every month between 1995 and 2005.

Dan: That’s a whole lot of stock studies.

Mark: Yes, and I had the newsprint-stained fingers and red eyes to prove it.

Dan: It was also not clear if after studying Buffett, Schloss and Ruane whether you applied the same or some of their rules they used or something you developed separately.

Mark: I messed up here. That’s not what I intended. I mentioned these guys for a variety of reasons: (1) To prove that beating the market is possible; (2) Warren Buffett makes very few transactions and has relatively few holdings; and (3) Walter Schloss uses much of the same information that we do. My intent was more to focus on the reality that Schloss and the others actually have an extraordinarily ordinary approach to success in investing. He “practices investing in a way that any ordinary investor can.”

Having said all of that, I believe there are striking similarities between their methods and the core of the MANIFEST approach.

Dan: One thing that stands out is the 10-year history that shows the portfolio tracked the VTSMX quite closely for about 4 years and then diverged in 1998/99. I think a more in depth explanation as to why this occurred would be of interest. You indicated this was due to companies like Wolverine, AutoZone, Worthington, Illinois Tool, Washington Mutual and Wendy’s. That is quite a mix and begs the question of how and when and why did you add and remove these from the portfolio? Did you use the Solomon database in this selection?

Making A Big Difference. How did stocks like AutoZone (AZO), WolverineWorldwide (WWW) and Wendy’s (WEN) make such a large difference in the TinCup portfolio during and after the bubble at the turn of the century? All threesignificantly outperformed the total stock market. Source:www.bigcharts.com

Mark: We’ll dedicate considerable attention to the learning opportunities. As you might imagine, I could write a book on what I’ve observed and in fact, am thinking about doing just that.

In a nutshell (for now), the answer to the last question is yes, the Solomon database and MANIFEST method was used exclusively. The short answer is that quality companies with low projected returns were replaced with quality companies with higher expected returns. The selling discipline was to sell a stock when its PAR was less than 13-week treasury yields. This is what happened with Oracle, EMC Corp and ADC Telecommunications. Take a look at the 10-year price chart of WWW, AZO and WEN on www.bigcharts.com. Note how they performed when the market headed south. This is what caused the divergence.Dan: Are the annualized returns of 30.5% and 10.1% for the Tin Cup and VTSMX comparable? By this I mean were the same amounts invested in each at the same point in time? Why not include the entire period in your Historical Performance Benchmarks bar chart?

Mark: Yes, matching investments are made into VTSMX. For a 10-year look at performance, see page 7.

Dan: How did you select which stocks to add to the portfolio? I know you used PAR and Quality, but did you simply pick the highest PAR (within the 5-10% target range) or did you apply other judgment?

Mark: Good question. No judgment could be allowed as this had to be a strictly-followed mechanical selection. I used a combination of PAR and quality to produce a “selection score” (specifically QR/2 + PAR*200) to generate the top stock within the target range. Unless the stock was an inordinately large -of-total-assets, that stock would be selected. This also underscores the reality that it’s not just projected returns that are important, but quality matters too. Quality became a sort of tiebreaker in some cases.

Dan: Will you consider sharing all of the details of transactions, etc. for Tin Cup?

Mark: Absolutely. We’ll post detailed records (all transactions and a ledger) on the site after the reviews are finished.

Dan: I suspect from the dollar amount this portfolio and your words this portfolio was in existence since 1995.

Mark: Not exactly, but it sort of feels that way, Dan. Why? Because so many of the transactions mirrored decisions made (particularly the buy decisions) in my family club and other clubs I’m affiliated with. One of my clubs has an annualized total return of 20.3 since 1994. The club performance tracked Tin Cup from 1995-99 but failed to keep up during 2000-04 because we got “cute” with cash positions. We should have been buying hush puppies (WWW) with that cash and the truth hurts a little.

Dan Hess: I am not sure I understand what you mean by net asset value for a stock portfolio.

Mark Robertson: It’s not any different than net asset value for a mutual fund or unit value for an investment club. In order to track total return (mutual fund style) we need a net asset value to track. In the same manner as an investment club, the portfolio started with a unit value (or net asset value) of $10.00 on January 1, 1995. New units are “issued” with each new monthly contribution to the model portfolio.

Dan: I was surprised to see Altria Group (MO), Wendy’s (WEN), New Plan Excel (NXL) and Masco Corp (MAS) in the portfolio. I suppose they have provided diversification.

Mark: Yes, diversification seemed to happen fairly naturally without “forcing” it. Some of those companies surprised me, too, although Wendy’s is among the largest holdings in our family club.

Some people have reservations about Altria Group (formerly Philip Morris) but the company has historically delivered substantial returns to its shareholders. Altria actually made two appearances in the Tin Cup portfolio. It was originally bought during May 1997 and sold during April 2002 to bolster the PAR of the portfolio. It returned in March 2003 with a PAR of 28.2% and a quality rating of 78.4. Take a look at a 10-year stock price chart of Altria Group and note the peak during April 2002 and the bottom (buying opportunity) during early 2003.

I recall “cringing” when Masco Corp came out ahead and was added to the portfolio in May 2000. Masco had a PAR of 25.1% and a quality rating of 90.0 at the time. The return on the Masco position is an annualized return of 9.6% during a period where the total stock market has declined. You may also recall that Masco was featured as a stock to study in Better Investing during August 2001.

Dan: Is the totals line a weighted average?

Mark: Yes. The larger positions have more influence on the average portfolio characteristics than the smaller positions.

Dan: Notable by their absence are technology stocks, other than the recent addition of Linear Technology (LLTC). What kept them off in the late 1990s? Similarly I see a lack of big pharmaceuticals?

Mark: The technology stocks were there. As mentioned previously, Oracle, EMC Corp and ADC Telecommunications were sold during the 1999-2000 stock market advance. In early 1995 many of the buying opportunities in healthcare, created by the legislative uncertainty of 1993 and 1994, had passed. I too was surprised. You will note that Pfizer was added when the preliminary results were “audited.” This also correlates pretty well with what we’ve seen in the investing community as Pfizer’s PAR soared as it approached $30.

Dan: I have asked a lot of questions and while it may even appear that I have been overly critical, I think that the Tin Cup model portfolio and the methodology merit closer attention. It does appear that Manifest Investing is “on” to something. This could work out well for investors.

Mark: I don’t see your remarks as critical at all. Rather, they seem to be prudent and appropriately skeptical. I believe that I’ve been even more critical and skeptical of the results. After all, I’ve run the 10-years of calculations twice and will probably run them one more time before publishing the results and then reaching out for an audit by a third party. They need to be tested, transparent and repeatable.

I found great comfort that the Tin Cup selections often lined up quite well with my own selections or the decisions made by my investment clubs. I believe that the selling discipline, based so soundly in the overall context of portfolio design and management will serve us extremely well going forward.

I believe that the potential is clear. By using projected annual returns and keeping a watchful eye on quality, it is possible to achieve success in investing in a way that any ordinary investor can. Thanks, Dan.

Mark Robertson

Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.