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Investment Analysis Clubs / Value Hounds
|Subject: WWJGII||Date: 11/17/2012 9:09 AM|
|Author: MrTompkins||Number: 12381 of 24366|
I have set out on a mission to rank companies by a relative measure to create an attractively valued portfolio of ~25 firms. The idea is the combination of low volatility (low beta), high quality, and fair value – essentially WWJGII (What Would Jeremy Grantham Invest In). The kernel of the idea started with the paper Buffett's Alpha (Frazzini, Kabiller, and Pedersen) and to find a way to create a repeatable process. I work much better when the opportunity set has been greatly reduced (25 versus 2,500).
On the road here to hopefully a successful process I wanted to share some of my efforts to give back to the community but also for constructive feedback. I don't want to disappoint anyone here, but this exercise is more on valuation and corporate finance than finding the next 10 bagger (although they are not mutually exclusive! Also the focus is on large caps but the logic can and should extend to smaller capitalized companies).
A bit of background might be in order. My introduction (and appeal) to the Fool was mainly through the Boring board. One of the things I picked up from the Boring Board, Fool on the Hill, etc. was the concept of EVA. So the prism I look at the investment world is largely shaped by Buffett's advice to think of stocks as companies and the concept of economic profits and invested capital.
So the process is pretty straightforward. First I have to keep it simple because what I am doing – anyone with Excel (sorry LibreOffice won't cut it) can do. No Factset, Capital IQ, or Thomson Baseline required. Essentially I am taking the last 20 quarters of financial data and creating a recent history of how a company has been valued relative to its invested capital. (I am using 20 quarters of data because that's the most I can get via the web.)
Now a challenge is that you want to create a reasonable historical view of the firm to get an accurate market multiple. To do that I use the actual closing prices and use the average closing price (not adjusted for dividends) for the quarter to calculate the EV for the quarter. Therefore the rolling 20 quarter history is the EV at that time and is unadjusted for cash distributed to shareholders via dividends.
I am using the Enterprise Value-to-Invested Capital (EV/IC) multiple as my main tool for valuation. In other words I am not making calculations on ROIC, WACC, or IC growth. I would likely make forward estimates only if I was doing more due diligence on a specific firm. Based on my review of valuations from Morningstar, who I believe also values equity by first estimating value at t