RSS FeedValue investors make a nice living for their clients and themselves by thoughtfully betting against those who say that it is difficult, if not impossible, to make money on stocks that are out of favor. The astute investor can adapt and profit from changes in the market.
At its roots, value investing is based upon the premise that it is possible to consistently find stocks that can be purchased at a discount to their true worth. The notion of value investing is made possible due to reliable valuation benchmarks that can be used to determine the true worth of any security, and the belief that these benchmarks remain relatively stable despite fluctuations in a stock’s price.
In any form of investing, discipline is imperative. Discipline helps to anchor an investor by taking the emotion out of the buy or sell decision. A well-conceived investment discipline focuses investors in areas they would otherwise avoid if they were following the Wall Street herd mentality. Likewise, a properly formulated investment discipline should provide clear and well-defined sell signals.
This is particularly important in a market prone to cyclical changes, which can cause managers to doubt their investment processes and become victims of their own emotions. Investment approaches come in and out of favor, and when the discipline followed is not in favor, it can be tempting to shift with the changes in market sentiment.
Traditional dividend-driven value investing need to be paired with a fresh approach that would allow investors to take advantage of the changes in the market while still not changing or compromising the underlying fundamentals of value investing. It was important to find a way to apply the disciplines inherent in value investing to a dynamic stock market.
Broadly speaking, value investing can be thought of as a disciplined process for identifying and investing in undervalued stocks with strong upside potential. Today there is a broad spectrum of disciplines that fall under the value umbrella, each attributable to investment managers attempting to respond to current market conditions. Well-known value investors ranging from Warren Buffet to Michael Price each take a unique approach to value investing.
Building a value-driven portfolio using Relative Dividend Yield (RDY) and Relative Price-to-Sales Ratio (RPSR) is essential to achieving successful value investing. Your portfolio construction should be driven by the desire to build a portfolio of the highest quality, most attractively valued companies.
In addition, you want to selectively diversify a portfolio to minimize longer-term volatility and outperform the market over the long term. Essentially, the RDY and RPSR methodologies should drive you into taking a growth-at-a-reasonable-price approach to investing.
To realize this goal, five key proprietary factors have been identified:
1. Concentration
2. Selecting only the “best” companies
3. Use of both RDY and RPSR stocks
4. Covariance
5. Weightings/Diversification
Concentration
The first principle of concentration is especially significant. It’s best to limit oneself to between twenty-five and thirty-five stocks. Additional holdings do not reduce portfolio standard deviation in any meaningful
way. A portfolio of twenty-five to thirty-five stocks results in an optimal blend to maximize performance without over diversifying, while maintaining reasonable levels of risk.
Selecting Only The Best Companies
In the investing industry, it is not uncommon to see a manager with fifty stocks, including perhaps twenty great stocks and thirty other stocks that are not so great, but that are required in order to meet the portfolio’s guidelines. The "only invest in the best rule" is particularly important when investing in fallen angel growth stocks, which require a high degree of selectivity via fundamental research.
Use Of Both RDY and RPSR Stocks
A portfolio that combines RDY and RPSR stocks offers several advantages: The RPSR stocks allow you to find situations where a return to a former growth curve, even at a more mod-est rate of climb, will fuel a company’s share price, providing a capital gains kicker. The RDY stocks provide the added leverage that dividends give to the portfolio, as well as exposure to some of the less-volatile sectors of the market.
Covariance
This fourth principle is managing covariance of return whenever possible, with covariance being a measure of correlation between various industries and sectors. Over time, certain industry groups and/or sectors tend to exhibit a strong negative covariance with each other: when one group is generating excess return, the other is under-performing. By considering covariance in the portfolio construction process, investors have the opportunity to reduce the overall volatility of the portfolio.
Weightings/Diversification
This principle is related to the weighting of both sectors and individual holdings. In terms of sector weightings, you should not, as a rule, allow a sector to reach more than twice the S&P sector weighting. Rarely, you may also choose to deliberately overweight a sector if you believe that the general economic conditions warrant doing so.
When you initially buy a stock, plan to hold it for a long period of time, typically one to three years. However, continually evaluate your current holdings against the universe of stocks meeting the RDY/RPSR and Twelve Fundamental Factors screens.
If a candidate stock is offering more promise than an existing holding, begin to rotate that stock into the portfolio, while rotating out the less attractive holding. These decisions are all based on what the stock looks like in terms of RDY or RPSR and what the Twelve Fundamental Factors analysis has revealed about each stock.
M. Isi Eromosele is
the President | Chief Executive Officer | Executive Creative Director of Oseme
Group - Oseme Creative | Oseme Consulting | Oseme Finance
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2012 Oseme Group
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