Share Sleuth Digest: Triggers for buying and selling

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This week: What triggers Share Sleuth. Also, portfolio news, analysis, and Academics v. analysts: MAFFIA take on the quantitative charlatans and three academics expose incompetent analysis.

By email a reader, Geoff, asked for Share Sleuth specifics:

  • What triggers you to add something to the portfolio?

  • What triggers you to remove something from the portfolio?

  • How do you communicate this to your followers?

  • He triggered something all right, a complete rewrite of the Share Sleuth portfolio page. Here's a tidied up version of my reply to each of his queries:

    The triggers depend on which of two categories the investment falls in. I recently christened them stalwarts and susceptibles:

    1. Stalwarts may already be better known to you as defensive companies and growth companies. I monitor the valuations of companies that have strong and fairly consistent returns on capital, strong finances, and competitive advantages I can articulate in the Share Sleuth watchlist. Watchlist companies join the portfolio on rare occasions when the market offers them to me at a favourable valuation. Recent examples are Rolls Royce and ITE. Typically a favourable valuation is an earnings yield of 8% or more. The earnings yield includes the value of the debt in the price (i.e. market capitalisation plus net debt or minus net cash). It's equivalent to a PE for the whole enterprise of 12.5. I hope to hold stalwarts forever, but may eject them if:

      1. Their valuations rise to ludicrous levels

      2. I no longer believe they are stalwarts, or

      3. The portfolio's holding rises to more than 10% of its total value.

    2. Susceptibles may already be known to you as turnarounds and cyclicals. The aim is to identify companies that will recover by ascertaining what they are susceptible to: competition, recession, prices of raw materials or finished commodities, mismanagement, and articulate why they might overcome those factors in the medium term, say the next five years. Operating results may be improving, debt levels may be shrinking, management may have changed. Trifast is a recent example of a successful turnaround. I prefer to add susceptibles at very low valuations: earnings yields above 10% to 12% and low price to book book ratios and hold them until:

      1. They are no longer on low valuations

      2. I no longer believe they are likely to turn around

      3. The portfolio's holding grows to more than 5% of a susceptible's total value

      4. A susceptible turns into a stalwart.

    I write up every bit of research and every trade in the blog and publicise it, and other interesting information on Twitter. All the data is in the portfolio spreadsheet and the watchlist spreadsheet. Thursday's blog post, this one, is a weekly digest of the research and occasionally, trades.

    I've revamped the spreadsheets too. If you'd like access to the working spreadsheets or to download copies, for example to use as a template for your own system, you'll need a Google account, and to send me the associated email address.

    Analysis

    ITE: Ukraine woes uncover value opportunity
    The annexation of Crimea and ongoing instability in Ukraine may have created opportunity for value investors. Shares in exhibition organiser ITE are attractive on a historical basis. The rub is concern about the region's future.

    Portfolio news.

    ITE joins Share Sleuth
    I've added 872 ITE shares to the Share Sleuth portfolio at a fraction below £2.10, the actual price quoted by a broker. The trade was made in haste, but is not regretted.

    In contrast, I've been putting off a decision about Cohort for days...

    Cohort enters value territory
    A slide in defence and technology consultancy Cohort's share price delivers the shares into value territory. Although past ill-discipline and defence cuts are concerns, it grinds out the results.

    Cohort contract wins offer hope
    Defence and technology consultancy Cohort has won contracts worth £6m. After a disappointing half-year, the news adds some credibility to management’s assertion the second half will be better.

    Sprue Aegis has reported full-year results and so has Air Partner. Analysis will follow straight after Easter.

    Trifast's debt reduction lesson
    Tuesday's announcement that fastener manufacturer Trifast expects it has entered its new financial year with nil debt is a vindication of management's strategy and a lesson for value investors.

    Watchlist news

    JD Sports Fashion has joined the Research list (second tab in the Watchlist spreadsheet). It retails sportswear. Networkers International has joined too. It recruits specialist staff in telecoms, IT, energy and financial markets.

    Noteworthy

    Maths professors expose quantitative quackery
    A study says lay investors are sold quantitative strategies on the basis of random signals that happen to perform well in selective backtesting.

    The four mathematicians behind the study have formed MAFFIA: Mathematicians Against Fraudulent Financial and Investment Advice.

    Another group of academics corrected 120 analyst reports and found the median analyst makes five theoretic or implementation errors and five dubious modelling judgements in their discounted cash flow analysis. Recalculating the analysts' target prices, the academics found the analysts were off by a median 37%:

    We conclude that with regard to valuing firms‘ equity, sell-side analysts are less sophisticated, and more optimistic, than prior research has supposed.

    Referring to a paper by Thomas Philippon of New York University, Paul Krugman says:

    ...society is devoting an ever-growing share of its resources to financial wheeling and dealing, while getting little or nothing in return.

    The paper estimates the waste caused by excessive trading is $2.8bn in the US alone.

    Money, Blood and Revolution, the book that says economics is a science crisis and suggests a way out of it, continues to get good reviews. I have a copy, and will be reviewing it after I have read and reviewed Understanding Michael Porter.

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