Review of Defensive Low PE Portfolio

This portfolio is made up of the 15 defensive stocks that are trading at the lowest PE Ratio.  Each month we will review the list, and make any trades necessary to get the portfolio to match the list.  The list of defensive stocks is made by following modernized Benjamin Graham strategies, and PE Ratio is calculated using an average of the previous 5 years’ earnings per share (EPS).

There were two dividend payments for this portfolio this week.  First, on 8/15, Lennar Corp (LEN) paid a dividend of $0.16 which was reinvested at the day’s closing price.  Then, on 8/16, Thornburg Mortgage paid a dividend of $0.68 which was also reinvested at the day’s closing price.

This portfolio significantly outperformed both the Dow Jones Industrial Average and the S&P 500 over the week. 

The current value is calculated using prices near close from Thursday.

The snapshot:

Ticker

Total Cost

Current Value

% Gain/Loss

ASH $6,490.00 $6,541.00 0.79%
BL $6,479.20 $6,509.70 0.47%
DHI $6,527.35 $6,851.25 4.96%
FAF $6,420.70 $6,815.30 6.15%
FNF $6,458.10 $6,766.00 4.77%
FRE $6,338.30 $6,697.90 5.67%
KBH $6,577.35 $6,816.90 3.64%
LEN $6,463.95 $6,692.93 3.54%
MDC $6,544.00 $6,721.50 2.71%
MTG $6,523.60 $7,105.20 8.92%
PHM $6,508.00 $6,795.00 4.41%
RYL $6,435.60 $6,916.80 7.48%
SPF $6,522.25 $6,925.50 6.18%
TMA $6,460.10 $6,522.41 0.96%
TOL $6,478.80 $6,686.89 3.21%
Cash $2,772.70
Total $100,000.00 $104,136.98 4.14%

Performance:

 

Last Week

This week

Change

Overall

S&P 1271.81 1297.48 2.02% 2.02%
Dow 11124.37 11334.96 1.89% 1.89%
Portfolio 99890.5 104137 4.25% 4.14%

Neither of us holds a position in any of these stocks.  Please review our disclaimer.

Using Discounted Cash Flows

One of Benjamin Graham’s greatest teachings is that when looking at the stock of a company and trying to value it, we should use the same approach as we would if we were to purchase a small business from a neighbor.  The only difference between the companies is size, so why should we as investors continually place more emphasis on the market’s speculation of stock price than the actual value?  Well, we shouldn’t.  We should only care about the intrinsic value of the company, and only purchase securities that are trading below that value.  Sounds pretty simple, doesn’t it? 

The complication comes in when we try to figure out the value of the company.  How does one go about doing that with accuracy?  Well, there are many approaches – one of which is the Discounted Cash Flow Analysis.  The idea is simple:  predict the future cash flows of the company and discount them to the present using the time value of money.  But Benjamin Graham taught us never to base our investments on predictions of the future, which are habitually wrong.

I believe that the intelligent investor can get around this prediction issue by believing another of Graham’s philosophies – the margin of error.  If you put a significant margin of error into your prediction, it becomes more reliable.  If I value a company at $35/share, but refuse to buy it unless it is trading below $26.25, I have a margin of error of 25%.  At that level I can feel more certain that I am not wrong.  

David Meier from The Motley Fool has written a nice article about using DCF, and the pitfalls against it.  The article can be found here:  http://www.fool.com/news/commentary/2005/commentary05032803.htm

Quicken.com has a very helpful tool for estimating the value of a company based on DCF.  To use it, go to http://www.quicken.com/investments/seceval/ and enter a ticker symbol.  After the evaluator comes up for the stock you enter, click on 5. Intrinsic Value.  There you can select different growth and discount rates to see how they affect the value.

~Ben

Discuss this post in our forum.

Value Investing Weekly – Issue 2

ValueInvesting Weekly
Issue 2
August 17, 2006

We discussed last week about general ideas in value investing, Ben Graham, Warren Buffett, and the psychology of investing. This week we are going to discuss an example of personal experience regarding speculating and the downfalls of doing so.

My personal experience included a wonderful, well-known stock named Sirius Satellite Radio (SIRI). Allow me to explain how I became involved in this security and the reasons for doing so. In the winter of 2004, I began trading SIRI on a “tip” from a relative, and throughout the course of a few months, I netted a healthy return on purely trading on volume. I felt that it was easy enough to buy the stock in the morning watch it throughout the day, and maybe hold it overnight before getting out for a profit. I became confident of this strategy and before I had ever taken a course was convinced of technical analysis.

Following the signing of big profile broadcasters, most notably Howard Stern, I felt that Sirius was ripe to explode purely because of Stern’s listening base and the potential increase of subscribers. Further, I thought of satellite radio as this generation’s cable television. I personally subscribe to Sirius, and actually really enjoy the programming.  I purchased shares in the fall of 2005 before Stern’s debut in January on Sirius. Instead of following my previous strategy, I decided to go long on Sirius because of my interpretation of expected growth. Grant you at the time, and currently, Sirius was loosing millions of dollars each quarter in trying to acquire subscribers and spur growth of the company. They hired a top notch CEO from Viacom, Mel Karmazin, who had a proven record of accomplishment in terrestrial radio over the years. Everything in my eyes looked great and I was merely waiting for the profits to come rolling in.

Well they did not; I purchased Sirius for a price of $7.12/share, with the closing price of Wednesday (8-16-06) at $3.65/share. I have incurred a net loss of 48.95% over the course of roughly a year and a half. So the questions are “Jon why did you ever buy this stock in the first place, you should have just looked at the financial statements and seen what was going on?”, and “Why did you stay in the position for so long?”

To answer the first question, I fell under the spell of what I call the “speculation potion” by that I mean you place rose colored glasses on and view the potential of a company not seeing the disaster in the waiting. I was convinced that if I didn’t get in on this stock, I would regret it just as I did Chicago Mercantile Exchange (CME), Google (GOOG), and countless others. What I realize now that I didn’t then is that in investing you must develop a strategy and stay the course. Further, as we spoke in last week’s issue, you become an owner of the company, not an owner of the stock. In my mind at the time ownership ended on the screen of my Ameritrade account.

The second question regarded why I didn’t and still haven’t exited my position. This issue is purely psychological as I was adamantly against having a loss and decided to hold the stock until it recovered the losses. I am coming to terms with my poor investment decision and am ready to exit my position. It is similar to Alcoholic’s Anonymous where everyone stands and states “Hi I am_____ and I’m an alcoholic”, well I am standing up and stating that I am a former speculator and am seeking treatment. Just for the record, I by no means am comparing the two; I am merely using this example for comic relief.

Where Sirius will go in the future is beyond me or anyone else, currently their financial position is worse then ever. The ROE for fiscal year 2005 was (265)mil, and its Q2Y2006 EPS where (.87) down from (.83) the quarter prior. Every aspect of Graham’s investing strategies screams to stay away from this stock. Although sales are increasing extraordinary, because of subscriber growth (see article below), expenses rise linearly as well.

Ending, I hope that you all learn something from my painful lesson, do research, think logically, don’t expect to become rich overnight, and never trust other’s judgment and research.

-Jon

ModernGraham.com

WSJ article on Sirius 
Reuters article on Sirius
Discuss this article in our forums. 

Review of Previous Companies of the Week

Well this is the first week that we have had a previous company of the week to review, so we will be reviewing Marine Products Corp (MPX).  You can read the original write-up on Marine Products Corp. here: https://www.moderngraham.com/blog/2006/08/company_of_the_week_marine_pro.html

As of the close yesterday, the stock was trading at $8.85.  This is a 4.2% increase since we first mentioned the company (last week).  

There has been no new news on the company since we wrote about it.

We still believe Marine Products Corp. may be a suitable investment for the enterprising intelligent investor follow Benjamin Graham’s value investing strategy.

Neither of us holds a position in Marine Products Corp.  Also, please remember to read our disclaimer.

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Company of the Week – Microsoft (MSFT)

This week I thought I’d use a little bit different approach to the company of the week.  Specifically, I wanted to bring Warren Buffett’s approach and strategy into play a little more.  So, using Robert Hagstrom’s The Warren Buffett Way, I have a list of Business and Management Tenets to consider with the company.  Hagstrom also mentions Financial and Value Tenets, but these are in essence the same as Benjamin Graham’s teachings.

Business & Management Review

1.  Is the business simple and understandable?

I believe this is a question that is dependent upon each investor’s understanding of the business.  For Warren Buffett, Microsoft probably would not pass this test, as it is a technology company and he has traditionally stayed away from technology for this very reason.  However, I feel that I understand Microsoft’s business plan, strategy, and believe it to be simple enough to be worthy of my further research.

2.  Does the business have a consistent operating history?

Microsoft has now been in business for 30 years, and has been an industry leader for over 15.  The company has not changed its approach significantly over time, but has gradually adopted new strategies and opportunities.  Overall, I believe the company has had a very consistent operating history.

3.  Does the business have favorable long-term prospects?

Long-term, I believe Microsoft will continue to be an industry leader.  Though competition is growing from other operating systems for computer servers, it is hard to imagine a world where the majority of computers do not run a version of Microsoft Windows.  The company is also pursuing other endeavors, in attempts to compete with Apple Computers (AAPL) and Google Inc (GOOG).

4.  Is management rational?

Recently, Chairman and Chief Software Architect Bill Gates announced that he will be stepping down and taking a reduced role with the company.  Current Chief Executive Officer Steve Ballmer will be increasing his control over the management of the company.  While on the surface this appears to be a change that could cause uncertainty over the future of the management of Microsoft, I believe that the approach the company is using to ease the transition will be beneficial long-term.  It is apparent that the company has been rationally preparing for this change of leadership for some time now, and Steve Ballmer’s history with the company and friendship with Bill Gates will lead to a smooth change.  You can read more about this transition in this Wall Street Journal article:  http://online.wsj.com/article/SB115405072580419987.html.

5.  Is management candid with its shareholders?

Microsoft has a very extensive Investor Relations page, located at http://www.microsoft.com/msft/default.mspx.

6.  Does management resist the institutional imperative?

I believe that the company does resist the institutional imperative.  Essentially, Buffett describes this phenomenon as when a company’s management tends to mimic the behaviors of other managers.  Microsoft in the past has tended to create its own approach to different situations, and clearly does not resist change – as evidenced by their recent announcement to enter the MP3 market to compete with Apple’s iPod.

Financial and Value Review

Microsoft has had a good financial history.  The company has had a positive net income for over 10 years, has a good current ratio, has increased EPS from 10 years ago by over 1/3, and currently pays a dividend.  Microsoft may be a suitable company for enterprising intelligent investors, but not defensive investors. 

Upon my review of the company, I have found that the company seems to be significantly undervalued, and believe there is strong potential for the company to reach $37/share within the next few years.

Jon currently holds a position in Microsoft (MSFT).  Also, please read our disclaimer.

Review of Enterprising Value Portfolio

This portfolio is made up of the 15 enterprising stocks that are trading at the lowest discount to their intrinsic value.  Each month we will review the list, and make any trades necessary to get the portfolio to match the list.  The list of enterprising stocks is made by following modernized Benjamin Graham strategies, and intrinsic value is calculated by a formula based on Graham’s overall philosophy of calculating value with a margin of safety.

 Since this is the first month of the portfolio, we will start with $100,000 and $10 commissions.  All of the stocks listed were “purchased” using prices from Wednesday’s close.  The current value is calculated using prices near close from Thursday.

The snapshot:

Ticker

Total Cost

Current Value

% Gain/Loss

Neither of us holds a position in any of these stocks.  Please review our disclaimer.

Review of Defensive Low PE Portfolio

This portfolio is made up of the 15 defensive stocks that are trading at the lowest PE Ratio.  Each month we will review the list, and make any trades necessary to get the portfolio to match the list.  The list of defensive stocks is made by following modernized Benjamin Graham strategies, and PE Ratio is calculated using an average of the previous 5 years’ earnings per share (EPS).

 Since this is the first month of the portfolio, we will start with $100,000 and $10 commissions.  All of the stocks listed were “purchased” using prices from Wednesday’s close.  The current value is calculated using prices near close from Thursday.

The snapshot:
>

Ticker

Total Cost

Current Value

% Gain/Loss

ASH $6,490.00 $6,433.00 -0.88%
BL $6,479.20 $6,547.50 1.05%
DHI $6,527.35 $6,501.60 -0.39%
FAF $6,420.70 $6,451.50 0.48%
FNF $6,458.10 $6,485.50 0.42%
FRE $6,338.30 $6,447.10 1.72%
KBH $6,577.35 $6,502.25 -1.14%
LEN $6,463.95 $6,426.40 -0.58%
MDC $6,544.00 $6,442.50 -1.55%
MTG $6,523.60 $6,582.00 0.90%
PHM $6,508.00 $6,453.00 -0.85%
RYL $6,435.60 $6,483.20 0.74%
SPF $6,522.25 $6,557.85 0.55%
TMA $6,460.10 $6,307.00 -2.37%
TOL $6,478.80 $6,497.40 0.29%
Cash   $2,772.70  
       
Total $100,000.00 $99,890.50 -0.11%

Neither of us holds a position in any of these stocks.  Please review our disclaimer.

Review of Defensive Value Portfolio

This portfolio is made up of the 15 defensive stocks that are trading at the lowest discount to their intrinsic value.  Each month we will review the list, and make any trades necessary to get the portfolio to match the list.  The list of defensive stocks is made by following modernized Benjamin Graham strategies, and intrinsic value is calculated by a formula based on Graham’s overall philosophy of calculating value with a margin of safety.

 Since this is the first month of the portfolio, we will start with $100,000 and $10 commissions.  All of the stocks listed were “purchased” using prices from Wednesday’s close.  The current value is calculated using prices near close from Thursday.

The snapshot:

Ticker Total Cost Current Value % Gain/Loss
ASH $6,490.00 $6,378.00 -1.73%
BC $6,427.00 $6,390.00 -0.58%
BL $6,479.20 $6,426.00 -0.82%
BPOP $6,506.50 $6,670.45 2.52%
CB $6,419.80 $6,558.30 2.16%
DHI $6,527.35 $6,734.70 3.18%
LEN $6,463.95 $6,521.20 0.89%
LUK $6,505.40 $5,943.15 -8.64%
MDC $6,544.00 $6,376.50 -2.56%
MNI $6,422.50 $6,034.50 -6.04%
NFB $6,524.20 $6,412.06 -1.72%
NYT $6,535.40 $6,563.75 0.43%
PHM $6,508.00 $6,599.25 1.40%
RYL $6,435.60 $6,788.80 5.49%
SPF $6,522.25 $6,540.75 0.28%
Cash $2,688.85
 
Total $100,000.00 $99,626.26 -0.37%

Performance:

Last Week This week Change Overall
S&P 1297.48 1296.06 -0.11% 1.91%
Dow 11334.96 11304.46 -0.27% 1.62%
Portfolio 102025.7 99626.26 -2.35% -0.37%

Neither of us holds a position in any of these stocks.  Please review our disclaimer.

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