My Watch List – August 31, 2010 (Value Line Issue 1)

I have completed my review of Issue 1 of Value Line and have added a number of stocks to my watch list. I will begin to selectively add valuations as time permits. I will generally focus on those companies that are either near new lows or that have a high earnings yield.

You will see that my valuations take the form of the total return (capital gains plus dividends) that is discounted in the current stock price based on today’s closing price. Please note that these are simplistic valuations based on the extrapolation into the future of the companies’ past performance, including net profit, return on equity, rate of reinvestment, share repurchases and average dividend yield, which may not be indicative of future performance. You should always do your own research.

You will notice that the majority of the stocks on the watch list are categorized as a “Good Business”. That is intentional as the fourth tenet of my investing blueprint is Buy Good Businesses. I want to have an active dashboard where I can easily track all these good businesses and zero in on the ones that Mr. Market is making available at a cheap price. The basic screen for Good Businesses was inspired by Buffett in his 1987 letter to shareholders.

Experience, however, indicates that the best business returns are usually achieved by companies that are doing something quite similar today to what they were doing five or ten years ago.  That is no argument for managerial complacency. Businesses always have opportunities to improve service, product lines, manufacturing techniques, and the like, and obviously these opportunities should be seized.  But a business that constantly encounters major change also encounters many chances for major error.  Furthermore, economic terrain that is forever shifting violently is ground on which it is difficult to build a fortress-like business franchise.  Such a franchise is usually the key to sustained high returns.

The Fortune study I mentioned earlier supports our view.  Only 25 of the 1,000 companies met two tests of economic excellence – an average return on equity of over 20% in the ten years, 1977 through 1986, and no year worse than 15% [emphasis added]. These business superstars were also stock market superstars: During the decade, 24 of the 25 outperformed the S&P 500.

To be categorized as a “Good Business”, I am looking for businesses that pass these Fortune tests. Given the severity of the recession, I might include a company that is close but not quite there. As you can see from the study, not many companies pass these stringent tests. If you are fishing in this pond, at least from a quantitative standpoint, you have eliminated many sub-par companies. Note that 24 out of 25 of the stocks that passed the Fortune screen outperformed the S&P over the decade preceding the study.

This approach for the watch list was also inspired by Mason Hawkins who said at a 2005 lecture at the Ben Graham Centre for Value Investing at the University of Western Ontario that he and his team revalue the top 200 businesses in the world every week to see if they are available for less than 60% of value.

By way of review, the other categories are as follows. The categories may be added to or evolve over time.

  1. Special Situation – restructuring, spin-off, bankruptcy, divestitures, etc.
  2. Book Value Aristocrat – exceptional book value growth over the past decade
  3. Strong Moat – evident durable competitive advantage
  4. Guru Purchase – recent purchase by a notable investor

Here is My Watch List for August 30, 2010

The author of this blog is NOT an investment, trading, legal, or tax advisor, and none of the information available through this blog is intended to provide tax, legal, investment or trading advice. Nothing provided through these posts constitutes a solicitation of the purchase or sale of securities/futures. The data and information presented in this blog entry is believed to be accurate but should not be relied upon by the user for any purpose. Any and all liability for the content or any omissions, including any inaccuracies, errors or misstatements in such data is expressly disclaimed.


3 thoughts on “My Watch List – August 31, 2010 (Value Line Issue 1)

  1. mals

    hi greg, have followed your blog for a while. i really like your thought process with respect to investing. so thanks for sharing it.

    re this spreadsheet – i have been meaning to create one. can you share it?

  2. Sandesh Trivedi

    I am just curious to know why do u have TATA motors on your watchlist? I dont think so it has any strong moat. Though they might be producing the cheapest car in the world that doesnt necessarily mean they have any moat. They dont have any advantages of scale and they dont even dominate any niche category in the automobile industry.


  3. Greg Speicher Post author

    Sandesh, I included Tata Motors on the list because they have consistently earned a high return on equity, albeit with leverage. I am including companies in the watch list if they meet the Fortune screen referenced by Buffett in the 1987 Berkshire letter. To pass the screen, a company needed to earn 20% ROE over the prior decade with no years less than 15%. Tata, for the most part, passes this test, but has a shorter history.

    Passing this screen does not necessarily mean that a company has a most, however, Bruce Greenwald of Columbia argues that consistently high ROE is quantitative evidence of a moat. He argues that if there is no moat, these abnormal returns on equity should be eroded away through competition.


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