value and opportunity

When I did my 2014 review a few days ago I observed the following:

Interesting for me is the fact that 4 of the 5 top losers were new positions whereas only 2 of the 5 best stocks (Koc, Citizens) were bought in 2014.

This leads of course to the question if any of what I have done here over the past 4 years has added any value. The good thing is: It is relatively easy to test the hypothesis. I just took the old starting portfolio and calculated roughly what the return would have been with a simple buy and hold. Let’s have a look at the numbers:

	% of prtf.	Perf 19.12.
AS Creation	7%	4,74%
Buzzi Unichem Spar Aktien	6%	15,52%
Vetropack	5%	-2,16%
Bijou Brigitte	5%	-37,25%
KSB VZ	5%	-21,59%
Frosta	5%	52,08%
EVN	5%	-9,97%
Ensco	5%	-30,04%
Westag	3%	28,29%
Hornbach	3%	31,10%
OMV	3%	-17,46%
Sto Vz	3%	53,67%
Fortum	3%	1,60%
Apogee	3%	257,00%
Tonnelerie	3%	139,10%
Medtronic	3%	136,00%
Einhell	2%	-27,18%
Tsakos	2%	-2,31%
WMF vz	2%	176,80%
Benetton	2%	51,07%
Ishares Utilities	3%	22,63%
Aire	3%	147,2%
DEGI International	3%	69,85%
CS Euroreal (980500)	2%	-7,37%
IVG Convertible 2014/2017	3%	0,00%
HT1 Funding	3%	85,33%
Drägerwerk Genüsse (WKNR 555071)	3%	143,55%

Weighted with the starting percentage (very crude, I know) this would have been resulted in a performance of ~35,5% over the last 4 years. This compares unfavorable both to the benchmark and my “active portfolio”.:

Over the 4 years the blog portfolio is now in existence, total performance has been 84,5% or ~16,6% p.a. This compares to 44,5% or 9,6% p.a. for the benchmark.

The initial portfolio would have underperformed the benchmark and is far away from the current portfolio. Despite selling some big winners early or even at a loss (Apogee, Medtronic, WMF), how did that come ?

First of all, I was able to hang on to some of the winners Like Draeger, HT1, Aire and TFF.

Secondly and in my opinion more important, I was able to get rid of most of the losers. The starting portfolio was much more a “mechanical” portfolio with a German focus. Based on past experience at that time it seemed to be a good idea to buy historically cheap stocks (low P/E, low P/B, high dividend yields) and speculate on a simple “Mean reversion”.

Bijou Brigitte for instance was one of the biggest retail success stories in the 2000s. They had the right concept and expanded fast. Then however, their system got copied and they were hit hard by the financial crisis in the Club Med countries. Looking back, the 2000s were clearly an exceptional period for them and nothing close to a “mean”. Although I sold them at a pretty high loss son afterwards, it was clearly the right decision as I could deploy the capital elsewhere with much better returns. It also taught me a good lesson that retail concepts are especially difficult to turn around. Bijou was conservatively managed with net cash, for other players with debt and long-term leases it is even much harder.The lesson here is: If you invest for “mean reversion” make sure, the mean doesn’t include too many exceptional periods….

Another example: Einhell, the German importer of cheap tools. The company always looked cheap and screened well, but looking deeper into the business model showed clearly the limits and unattractiveness of its business. Many cheap stocks are cheap for a reason and in Einhell’s case it was the problem that the “cheap imports” business model had no leverage at all with regard to clients. Secondly, on of my mental models turned out right this time as well: if your customers have problems (in that case now bankrupt Praktiker) then there is much more downside than upside

Advantages of buy and hold portolios

Buy and hold investing has some clear advantages which are relatively easy to understand and quantify:

+ lower trading costs
+ tax advantages against trading often (Germany: 30% tax on realized gains, reduces available capital to compound)
+ long term returns are driven by compounding, not market timing etc. Buy and hold reduces incentive to trade/market time

So of course it is better to own great stocks which increase continiously in value and without paying taxes on realized gains.

Buy and Hold for everyone ?

This brings us back to the title and core point of this post: Is Buy and hold investing suitable for everyone ?

Warren Buffett is always quoted that you should buy and hold stocks forever. This is an particularily good strategy if you are already an investment genius and know exactly which stocks to pick. For anyone else I think “continous improvement” is the preferable strategy. Start out with a porfolio and then keep improving it day by day.

When we started the blog, we were average or maybe slightly above average “value investors”. Yes, we had read all the relevant stuff from Graham to Buffet to Klarman to Greenwald. Nevertheless, from reading books to really being able to pick stocks with a higher than purely random probability to outperform there is still a long way to go.

Personally for me, coming from a more “Graham” kind of mechanical approach, during the last 4 years the main learnings were:

– importance of competitive environment
– management and capital allocation
– better know-how about sectors retail, energy (now I know what I don’tknow)
– Understanding why a company is cheap and having an opinion on it before buying cheap stocks

I think those insights have clearly contributed to the performance improvement on top of the always necessary healthy dose of luck.

For almost any investor either starting to invest or starting to build up a portfolio, it is virtually impossible to create a great buy and hold portfolio from scratch. But as you have to start somewhere, what is the best strategy ?

Theoretically, you could do the “fat pitch” approach: ou start with a cash only portfolio and then read and analyse as many companies as you can. Only if you encounter a really great opportunity, you hit the pitch. However, i do think that this approach is quite unrealistic.

First, it is relatively boring and secondly you need a certain kind of personality to hold this through, especially if you are in a raging bull market etc. For me, the more realistic approach is the one of “continuous portfolio improvement”, meaning that you try to start somewhere and the step by step improve your portfolio.

A simple “step by step” improvement process

1. Write down the major points of your investment case plus a target range

This is essential. Write it down in a few bullet points, you don’t need to do it excessively

+ why is the stock cheap ? How much could it be worth ?
+ what needs to happen that the price goes up ?
+ How long will this take ?

2. Check on a regular basis (annual) the following points

Check your positions at least once a year. Ask yourself:

1. has the something fundamentally changed and impacted the fair/intrinsic value ? If yes, calculate new range of values.
2. has the price moved significantly ?
3. Where are you within your expected time frame ?

3. Decision making & adjusting portfolio

What follows is a kind of very crude decision matrix which one could apply on an annual basis

Case A) Fundamentals have improved, price has remained constant or even gone down —> buy more, time frame irrelevant
Case B) Fundamentals have improved, price has gone up –> calculate new “fair value” –> if price still below intrinsic value hold or buy more, time frame irrelevant
Case C) Fundamentals stayed the same, price has remained constant –> do nothing if you are within time frame, sell if time is over
Case D) Fundamentals stayed the same, price has risen above value range —> sell
Case E) Fundamentals stayed the same, price has dropped significantly —> make extra sure that you don’t miss something –> buy more carefully !!
Case F) Fundamentals have worsened permanently –> sell, irrespective of price
Case G) Fundamentals have worsened temporarily –> do nothing if you are within time frame, sell if time is over

This reflects to a certain extent my current process. The short version of this would be something like: Don’t double down on losers, double down on the winners if they have fundamental tailwinds. Time plays for you if you own good companies. To be honest, I often violated those rules and mostly to my regret.

So to summarize this whole thing quickly:

Buy and hold investing is clearly the “holy grail” when it comes to long term compounding of wealth for any tax paying person. However, buy and hold is something which is not reasonably achievable at the start of an investment journey.

It is rather a state which should be pursued over one’s investment carreer and with the goal to come as closely as possible. The way to achieve this should be a continious portfolio improvement process.

The single most important thing in improving is to WRITE DOWN the reasons why a stock has been bought. Only then you are able to test against this and act accordingly.

No one is born as investment genius not even Warren Buffett who took some time and the friendship of Charlie Munger to achieve his current fame and even he needs tosome improvement from time to time as the Tesco investment clearly showed.