I have been having discussions with Richard Beddard about value-based portfolios, whether they worked, and under what circumstances. My view is that deeper value shares only provide truly superior performance, as a class, coming out of bear markets. I don't think this is where we find the markets today, so I consider mechanical value-based strategies to be risky propositions at this point in time. That's not going to stop me in what I am about to do, though. I also take inspiration from Joel Greenblatt and his Magical Formula. I am a little skeptical of his formula, though, as people have reported results that are less than the returns that he claims to have. It is also too difficult to replicate his precise calculations, not least because he hasn't laid them out in precise detail. 

Another source that I am taking inspiration from is Stingy Investor, who is doing exceptionally well with a Ben Graham formula. The portfolio has thrashed, and I do mean thrashed, the S&P500 over a decade, having returned 18.1% annually. Good enough for you? The formula is very restrictive, and tends to throw up very few stocks. I have decided to broaden and simplify their approach into just two basic criteria: balance sheet safety, and cheapness. Here are the exact criteria I used:

  • Market cap > £200m - for adequate size and low spreads
  • Z-score > 3 - the balance sheet safety measure
  • PTBV (Price to Tangible Book Value) > 0 - I don't want any company with negative tangible equity
  • PER > 0 - I want to ensure some earnings
  • Operating margin > 0 - this just ensures that earnings aren't made positive by exceptional gains

I rank the results by ascending PTBV.

It is easy to run this screen using Sharelock Holmes. I then run through the results, from top to bottom, selecting 10 shares. I want to diversify by sector. Seeings as the results tend to be clustered in the same sectors, I allow only two companies per sector. I also apply some very lightweight rationalising to my selection. For example, I will allow two miners in, but not if they're both platinum miners; and I consider oil producers to be the same as miners. I have also excluded REITs, because they tend to trade on low book values anyway, and I think they are similar-ish to housebuilders. Similarly,…

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