Introducing Our Tin Cup Portfolio
Cover Story, by Mark Robertson, Managing Partner May 1st, 2005
"If the stock market were truly efficient, I'd be a bum on the street corner with a tin cup." - Warren Buffett.
Introducing Our “Tin Cup” Portfolio
“If the stock market were truly efficient, I’d be a bum on the street corner with a tin cup.” – Warren Buffett.
The mission of Manifest Investing is to dramatically simplify the world of investing and to transform the experience of individual investors into something less mysterious, less stressful and more successful.
In this issue, we introduce our “Tin Cup” model portfolio. The process of building this model portfolio ranks as one of the most exciting and intriguing things I’ve seen in my years of investing research. It’s intriguing because it’s a fairly simple implementation of the things we know are important in investing. It’s exciting because the results are staggering, at least so far.
What was the premise behind the study? Simple. Can ordinary people identify buying (and selling) opportunities with widely-available information?
I have been greatly influenced by an article published in Fortune magazine on April 3, 1995 entitled, “YES! You can BEAT the Market!” The article explored the achievements of Warren Buffett and his colleague Charlie Munger at Berkshire Hathaway. It also examined the long-term success of Bill Ruane of the Sequoia fund and highly-successful money manager Walter Schloss.
The article was actually a follow up piece to a virtually identical discussion of long-term investing success that Fortune had published in 1983. In a nutshell, the song had remained the same.
One of the underlying themes of the article is the conventional advice that it’s actually not possible to outperform the stock market over extended periods. “Like the shadows darkening the twisted canyons of Wall Street itself, one hard truth has hung over investors for more than a generation: You can not beat the stock market. No matter how smart you are or how hard you try or how well you do in the short run, inevitably the market will pound your returns down to the average (and probably worse) before you get to the finish line.”
“Don’t believe it. As it turns out, that bedrock principle of investing may be one of the four great lies. The simple fairly astonishing truth is that you can beat the market,” and Buffett, Munger, Ruane and Schloss are living proof.
According to the efficient market theory, the price of a stock always reflects the best estimate of its value. In other words, stock prices are always right and it’s impossible to take advantage of buying opportunities.
Warren Buffett’s conclusion regarding the theory is swift and decisive, “I’d be a bum on the street with a tin cup if the stock market were efficient.”
Walter Schloss has been beating the S&P 500 since before there was an S&P 500. In 1995, “over 39 years of investing had delivered annualized returns of slightly over 20%” to the clients of Walter Schloss. Perhaps one of the more intriguing aspects of his approach is how “ordinary” it is. "Described by someone who knows him well as a ‘man of modest talent and light work habits’ Schloss practices investing in a way that any ordinary investor can. Dressed in a well-worn traders smock, Schloss works entirely from public documents and a few publications like Value Line in one cramped, little office squirrelly with annual reports, 10-Ks, pictures of Babe Ruth, Lou Gehrig and Walter’s children and grandchildren.
The words bear repeating with emphasis: “practices investing in a way that any ordinary investor can.” People often believe that these successful investors leap tall buildings and dance on water.
Close, no cigar. They hop over puddles and dance on tall buildings. It’s all about common sense. Don’t ever pay more for something than it’s worth. In order to follow that sage advice, an investor has to understand the quality of a prospective investment and I believe, build expectations to know whether the current price is likely to experience sufficient price appreciation over the long term. So the theory and mission came clear: Might we be able to use Value Line and our notions of quality and expected returns to build and manage a portfolio starting in January 1995?
Rules of Engagement
I pulled out some piles of paper Value Line company reports as well as a stack of CDs to begin the quest. Using only the information available at the time of publication, I began building and maintaining a portfolio. The rules were strictly adhered to in order to avoid any bias. This was an ordinary “robot,” drinking tea and following a well-grounded method of stock selection. Stocks were screened seeking a certain range of projected annual return (PAR), 5-10 percentage points higher than the Value Line Median Appreciation Projection (VLMAP) at the time. For example, VLMAP was 65% (13.3% annualized) on May 1, 1998. Only stocks with projected annual returns between 18.3-23.3% would be considered for purchase. I now think of this target range as a “sweet spot” to avoid the speculation of returns that are, quite simply, too good to be true.
To account for quality, financial strength was used as a screening proxy. I defined a discipline to assure that only the highest quality stocks would be purchased when projected annual returns were low. With VLMAP at 12% or less, only stocks with financial strength ratings of “A” or better were eligible for consideration. With VLMAP at 12-16%, stocks with a B++ financial strength or better were eligible. On those relatively rare occasions when VLMAP was greater than 20%, stocks with a financial strength rating of B+ were allowed into the mix.
The portfolio was limited to 12-20 stocks. How was selling accomplished? Stocks were sold if their projected annual return dropped below the returns available from 13-week treasury bills. Very few stocks actually reached this condition over the ten year period. The other condition for selling a stock was to restore the overall portfolio PAR to the target range. In these instances a stock with a PAR greater than 13-week T-bills could still be sold (using the Challenge process) to maintain portfolio PAR at sufficient levels. The replacement stock had to improve the portfolio projected return. The resultant portfolio turnover was actually quite low. One stock was sold during 2002 and no stocks were sold during 2003. The average portfolio turnover for 2000-04 was 15.3%.
“Tin Cup” Results. The 10-year results for the model portfolio are displayed. Tin Cup handled the late-90s bull market well, but the ensuing bear market even better on the backs of companies like Wolverine Worldwide, AutoZone, Worthington Industries, Illinois Tool Works, Washington Mutual and Wendy’s.
The Bottom Line…
We’ll be talking about these findings for a while, but here are some highlights. On average, the monthly deposits were $850. This results in a total of $103,700 invested since 1995. Investing this in the Vanguard Total Stock Market Index (VTSMX) would have attained a value of $138,377 on 3/31/05. The ending value of “Tin Cup” was $617,403 on 3/31/05, an annualized total return of 31.8% versus 9.1% for VTSMX.
I was extremely careful. Although mistakes could have been made along the way, I don’t expect them to be substantial. Please consider these results at this point as preliminary. I have confidence that the outcome, after an “audit” of the results, will not be materially different.
Intrigued? I hope so. I look forward to exploring the possibilities and opportunities.