Historical Results and Commentary
August 11, 2003
Holdings
|
|
11-Aug |
|
1 |
F |
|
2 |
NBG |
|
3 |
YHOO |
|
4 |
NKE |
|
5 |
BA |
|
6 |
VRSN |
|
7 |
JDSU |
|
8 |
CAT |
|
9 |
JNJ |
|
10 |
NSM |
|
11 |
CA |
|
12 |
FNF |
|
13 |
MSFT |
|
14 |
TKC |
|
15 |
HMC |
|
16 |
CRYP |
|
17 |
X |
|
18 |
AAPL |
|
19 |
COP |
|
20 |
WB |
Performance of Individual Stocks For last 3 months:
|
11-Aug |
|
|
FNF |
2.75% |
|
COP |
6.97% |
|
CAT |
30.01% |
|
NKE |
-2.10% |
|
BA |
11.36% |
|
VRSN |
9.43% |
|
JDSU |
-10.70% |
|
YHOO |
15.42% |
|
JNJ |
-7.88% |
|
NSM |
4.83% |
|
CA |
43.69% |
|
F |
9.32% |
|
MSFT |
-2.86% |
|
TKC |
26.69% |
|
HMC |
13.88% |
|
CRYP |
14.13% |
|
X |
16.58% |
|
AAPL |
7.43% |
|
NBG |
31.31% |
|
WB |
10.85% |
Total Increase (Decrease) since last quarter: 11.56%
Additions: None
Subtractions: None
Commentary:
In previous quarterly commentaries I have talked about a number of strategies that one might consider employing when deciding a framework for the selection of stocks. After some thought, I feel that the guidelines that follow worth considering when evaluating whether or not to acquire a certain stock. I call this principle the magic question principle.
The Magic Question
Principle
When purchasing a stock, I always ask myself one question: Sometime in the next 4 years, am I at least 80 percent certain that the value of this stock will rise by 50 percent? If the answer is yes, I consider buying. If the answer is no, I rarely buy unless there is a compelling reason to ignore this rule of thumb. To some, a 50 percent increase in 4 years seems like a low rate of return. But the catch here is that the rate of return is not 50 percent in 4 years. It is 50 percent sometime over the next four years. Some undervalued stocks immediately surge, while others are dormant for some time before rising. If the distribution of this sometime is completely random, you will end up with an annual rate of return on your portfolio of around 19.5 percent per year, provided your 20 percent laggards retain their original value. And this is not even including dividend payouts! That’s way better than any mutual fund I know of over the long haul. Even if you can’t consistently produce these results, if one even comes close, he or she will probably beat the major indices over any considerable length of time.
Of course, it’s somewhat silly to assume a random distribution of stock movements over time. This is because the odds of a stock jumping 50 percent overnight are much less than the odds of such a stock jumping by 50 percent over 3 or 4 years. So, to improve upon this model, let’s assign some weights to different scenarios, where later price appreciation is considered more probable than rapid price appreciation. The weights in the following table are somewhat arbitrary, but hey, it’s a theoretical model, so they can be.
|
Scenario: |
Scenario
1 |
Scenario
2 |
Scenario
3 |
Scenario
4 |
Scenario
5 |
Scenario
6 |
Scenario
7 |
Scenario
8 |
Scenario
9 |
Scenario
10 |
Expected
Return |
Yearly
ROI |
|
Time to
50 percent increase |
6 months |
1 year |
1.5 years |
2 years |
2.5 years |
3 years |
3.5 years |
4 years |
Stagnant |
4 years =
0 |
|
|
|
Value at
T=6months |
1.5 |
1.25 |
1.16666667 |
1.125 |
1.1 |
1.08333333 |
1.07142857 |
1.0625 |
1 |
0.875 |
|
15.86% |
|
Weight |
0.022 |
0.044 |
0.067 |
0.089 |
0.111 |
0.133 |
0.156 |
0.178 |
0.100 |
0.100 |
|
|
In scenarios 1-8, the stock has a 50 percent price increase that is stretched out over time intervals ranging between 6 months and 4 years. In scenario 9 the price appreciation is considered to be stagnant, and in scenario 10, the stock slowly loses value until it reaches 0 in 4 years. Scenarios 9 and 10 are each given a 10 percent weight in the model.
This simple model yields an expected return of 15.86 percent per year. Not too bad. Also, dividends are ignored, so including dividends the overall appreciation could be much higher.
What does this model tell us? Well, nothing really. It merely shows that a few stocks that rapidly appreciate, combined with a large number of slowly growing stocks, and a few duds, will create reasonable returns over time.
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Historical Results and Commentary