Value Investing in 2010 - A Review in Three Parts

Part 1 - The Benefits of Not Buying a Ferrari

I'm still here, I'm still investing, and I didn't buy a Ferrari.  This years take-away lesson for me was that sticking with the plan and not spending your savings are both Good Things To Do. 

It's easy to talk about valuations, rebalancing, asset allocation, analyst projections and all the other stuff that private and professional investors love to bang on about.  But for me the most important thing is to just stay in the game and not get blown off track by the things that life throws at you.

Since selling my house in 2004 and 'lucking' into a sizeable chunk of capital, there have been an enormous number of things in the outside world that have wanted a slice of that money.  The two big chunks that escaped out of the ISA before I got serious about investing went into a Jaguar XK8 (which I had for two years and it lost about 20% a year - not a good investment even including the fun factor) and a franchise business for my wife (which has returned about 30% a year so far in a tough recession, so a somewhat better investment than the Jag).

Other than that I've fought off countless urges to spend the money on various enjoyable but ultimately goal-defeating items.  That is my main achievement for the year and hopefully that'll be a pattern that lasts into the distant future.

Part 2 - Cut the Crap, How Did The Portfolio Do?

Things were going okay until December which was crazy.  It produced a 12% gain which took the results for the year to over 22%, which is 10% clear of the iShares FTSE 100 ETF total return benchmark.  2010 is safely in the bag with results that were well worth the effort.

Relative to other small cap funds the results are not quite so impressive.  For example the Standard Life UK Smaller Companies fund managed 47% and on www.trustnet.com the smaller companies sector was up 30%.  In blog-land Mr Beddard over at Interactive Investor was up 27% and the amazing Running Capital managed 58%, although with a much higher work rate than my good lazy self.  Overall it seems to have been good times galore in the small cap camp. 

Part 3 - 2011

2011 starts off with my recently changed strategy, although I hope the changes are evolutionary and not revolutionary as they like to say in F1. 

There was a problem in mid to late 2010 where I think my fund under performed relative to some of my peers.  This was likely due to a feature of my old investing style where those companies that performed well (reached a price/book ratio of 1) were sold, while those that did poorly were kept on.  Eventually this led to a portfolio with an increasing proportion of weak businesses who were perhaps really not worth book value  (their average ROE10 was 5.7%).  A portfolio to deservedly cheap companies is not a good place to be.

To fix that I have changed my approach somewhat as detailed in recent posts.  A further tweak to those changes is that I will force myself at gunpoint to make one trade per month.  Each month I'll sell the least undervalued company (or use existing cash) and buy the most undervalued company in the market, by my measures.  If I hold twenty companies this should give an average holding period of twenty months, which is slap bang in the middle of the range where value shares outperform the wider market (citations needed but I don't have them to hand now - just take it as given that value shares don't out perform over 3 months and they don't outperform over 10 years, the sweet spot is somewere in between).

Following on from the last post where I quickly covered the sale of the old guard and their mighty balance sheets and weak earnings, below are the new entries that will carry me forward into 2011, along with the main metrics I currently use to generate a 'reasonable' valuation:

Company        ROE10  ROE5  ROE3  Avg   p/b
Barratt        14.3   7.3   1.8   7.8   0.25
AGA            9.2    7.8   5.4   7.5   0.42
Vislink        9.5    13.5  12.0  11.7  0.61
Airea          6.7    2.6   0.7   3.3   0.33
Belgravium     20.9   10.1  8.1   13.0  0.34
Tribal         7.3    7.5   7.8   7.5   0.25
Interserve     21.5   26.3  27.0  24.9  1.22
Flying Brands  25.7   22.2  21.5  23.1  1.33
Creston        7.5    11.2  11.2  10.0  0.55

As I'd expect, the companies that have produced the highest returns on equity generally have the highest market price for that equity, but the price/book ratios are still low and the combination of low price/book and relatively high ROE figures are where I hope to make my gains in 2011.

Part 4 - The Blog

I'd like to say thanks to all readers who comment in such measured and thoughtful ways, the blogging game would be a boring one without your input.  And to those that just read,  I doff my cap in your general direction repeatedly each day. 

I hope 2011 serves you well.