I want to make a confession, one many might find bizarre coming from any equity investor and especially from one who has been a professional in the markets since 1980. Are you sitting down? Hopefully you are. OK. Here goes: I have no idea what stocks I own.  (And I hate being asked at social gatherings, even among other market-pros, what stocks I like. But I have at least gotten better at changing the topic.)

Really! I can’t name a single one, and I have a lot, almost 100.

By the way, I’m not talking about funds. These are individual-company stocks, the sorts of entities I spent almost 20 years calling, analyzing in detail, and writing about back when I was at Value Line and which I continued to write since then on various web sites. (Speaking of funds, I also have about 10 closed-ends, but I am consistent; I can’t name any of those either.) I should mention, too, that I made each of these trades myself, so it’s not as if I can plead ignorance as a result of having given somebody else trading discretion regarding my money.

How, you may wonder, did I get 100 or so stocks and about 10 funds into my account without knowing what they were? Good question.

Here’s how I did it. At specific intervals, I went onto Portfolio123, opened up the models I saved there and which I use for real-money investing. I download the newest up-to-date stock lists into Excel spreadsheets. I copy the tickers onto another spreadsheet I saved as something like “Trading Folio – Model Such-and-Such”). I also copy the percentage weights each ticker is supposed to have. I check to see that the weights add to 100.00 and if they don’t (as can happen when decimals get rounded), I manually fudge it to get the total to be correct.  And then, each of these spreadsheets gets uploaded into the appropriate part of my account at FolioInvesting.com.  And that’s that, until the next rebalancing date comes around.

I could see what stocks and funds I’m buying and selling if I want to.  The spreadsheets I download form Portfolio123 show me the up-to-date holdings lists. But I don’t care. I just copy the tickers.  As I enter the information into FolioInvesting, that site shows me what I’m buying and selling. I still don’t care. I just scroll down and keep clicking on the icons needed to get me to the next screen and to complete the process as quickly as possible.

Is This Approach REALLY Prudent?

Yeah, it is. Actually, I’ll go one up. I think it’s more prudent than focusing on the individual names. Doing it this way, while I may not know specifically WHAT I’m buying and selling, you can bet your you-know-what I know exactly WHY I’m trading as I am. And that, I believe, is where the money is: It’s in “why,” not “what.”

It’s been 18 trading days now since I’ve been disseminating the picks from my Cherry-picking the Blue Chips stock model as a portfolio on Harvest. For those new to this model, it’s one I make available for free on Portfolio123’s Ready-to-Go platform. It was described in detail here on March 12, 2015.  That introductory article included an 18-slide PDF presentation in which I explained in detail what the buying and selling rules were. And I shared some test data that supports my belief that this is a good set of rules. (And by the way, this is not data mining. Every rule is supported by a valid reason, the sort I’d feel comfortable discussing with anybody, Warren Buffett, Ben Graham, you . . .)

Quantitative models are not new. Web site have had screeners from way back when www stood for world-wide-wait.  But what, exactly, are the screens supposed to be telling us?

Originally, they were supposed to be idea generators. There are thousands of stocks out there. We can’t evaluate them all.  So if we can use these screeners to narrow the field and make our work manageable, we’d be way ahead of the game.  This was perfectly true and valid from day one.  It was perfectly true and valid when each of my two books on stock screening was published. And it remains true and valid today.

But today, we can go further. With testing capabilities such as those on Portfolio123 and with a brokerage firm like FolioInvesting that allows customers to trade baskets of stocks (they call them “folios”) without trading costs blowing up an otherwise sensible strategy,  I no longer need to continue to sweat over individual stock analysis presented to me through an idea-generating screen. Now, I can, not only benefit from the accumulated wisdom of fundamental analysis (and there’s a heck of a lot more of this out there than many realize), but also from the laws of statistical probability.

A Portfolio is More Than the Sum of its Stocks

Even after I got access to backtesting and Folio Investing, I continued for a while to force my will onto my models. I used to look more closely at the ticker lists, and drop those I thought were dogs. (Modeling is necessarily an inexact science so stocks that pass muster may still turn you off for other reasons.)

But as I compared the impact of my so-called superior analytic judgment to a mere screen, I more often than not found myself on the short end of the stick. In other words, my performance was turning out worse than it would have been had I just followed the model as-is. Over time, I’ve come to realize that if a model isn’t really serving me as well as I think it should, then that’s a cue to reassess and if possible improve the model in question. It’s not an invitation to push my weight around and overrule individual selections.

As a long-time securities analyst, this has been a hard pill to swallow. But it’s a pill that makes sense.

Here’s the deal. If you want the benefits of a model (presumably, one that is sensible and supported by research), then you have to own the output of the model. If you pick and choose, you’re on your own, no matter how good the list from which you’ve ben picking and choosing.

Back in May, I pretty much said just that to subscribers to the Forbes Low-Priced Stock Report. This is a high risk-high-reward portfolio of stocks priced below $10.  Performance among Individual stocks can vary wildly, from stupendous to disastrous. But by owning the entire 40-stock Master List in my FolioInvesting account, I received the full benefits of what may have been one of the best models I ever created. The model was designed to capture certain attributes of low-priced stock I found important, and in that commentary (see here), I demonstrated how the 40 stocks on average had the very qualities I sought. The key is on average. When you drill down to individual names, different stocks have different traits, but few have them all.  So to benefit from the traits I saw as bullish for low-priced stocks, one would need to own the portfolio constructed on the basis of those traits. In other words, we might think of the portfolio as a single super-security. Any individual stock separated from the portfolio becomes about as useful as a finger separated from the rest of the person.

We can even see a bit of this in action right now with the “Cherry-picking the Blue Chips” model. During the short span since the model came onto Harvest as a portfolio, 22 stocks in total have spent at least a week in the 10-stock (weekly rebalanced) portfolio. Individually, the biggest gainer during the course of these 18 trading days jumped 13.4%. Over the same period, my chosen benchmark, the S&P 500 Equal Weight Index, fell 2%.

Wouldn’t you have loved to just own the 13.4% gainer and have been able to ignore the rest! Sure. Who could argue against that? One problem: I know what the winner is now, looking with 20-20 hindsight. It was Valero Energy ($VLO). But would you have picked it out back on day one? Really? As to me, no way! (I don’t understand that sector and am scared of it.) The worst performer posted a 9.4% loss and on average, these 22 stocks broke even (zero for all practical purposes). So had I pursued the best of the best, I’d have had to do a ton of work and the risk of a big screw up. Why not just buy the model: During the same span, the 10 stock portfolio (with different names on the list at different times), rose 5.1%. What would have been the point to trying to beat the model?

This plays out in the fundamentals as well. The idea of the Cherry-picking model is to select big-cap super-liquid issues (S&P 500 constituent companies) that are of generally good quality and of particular interest at this time based on favorable valuation and analyst sentiment.  That’s the idea I’m pursuing. I care about the idea, not which particular stocks meet the criteria. That’s important to me. Value and sentiment, the strange bedfellow teaming together to cheery-pick among better-quality blue chip stocks.

As to value, the best (lowest) among the 22 stocks in terms of Enterprise Value to Sales and forward PE (using the estimate of EPS for the current fiscal year) were 0.32 and 9.11 respectively. Nice. Those are very low valuations. But individual picking and choosing could have gotten you much less favorable ratios of 4.05 and 19.65. Among the ten stocks in the portfolio today, valuation ratios could have ranged from highs of 2.53 and 16.48 to lows of 0.32 and 9.11. But if you own the whole portfolio, rather than swinging for the fences and risking the opportunities to strike out, you wind up with solid averages of 1.22 (for EV to Sales) and 13.13 (for PE).

As to analyst sentiment, let’s consider the average rating (1 is most bullish, 5 is theoretically most bearish, if they say Sell, or 3 if we assume Hold means Sell). The 22 stocks range from 1.5 to 3.0 and ten stocks in the portfolio today range from 1.64 to 3. Again, you can go for broke, or wind up with dogs. But if you simply own the portfolio, you wind up with a nice, solidly bullish average rating of 2.1.

We see the same looking at trailing return on equity. The 22 stocks range from a high of 29.67% to a low of 8.34%, while 10 sticks in the portfolio today range from 29.67% to 10.23%. So yet again, we can wind up doing great by picking and choosing, or missing the boat. If we simply own the portfolio, we have a nice, solid 10-stock average of 16.81%.

I could go on and on, but I think you get the message.

But why not just look at the smaller list, say today’s collection of ten stocks, and take the one with the best set of numbers. Would that life could be so simple. In reality, each company is best at one thing and bad or run of the mill at the other things. So you may wind up with the best ROE among today’s group, but one of the worst valuations. The only way to get fundamentals that truly reflect what you’re trying to achieve, and to do so across the board, is to own the portfolio.

This is no guarantee of successful results. If the idea I’m pursuing doesn’t work, or is temporarily out of favor, then results won’t look so good. But if/when that happens, I’ll at least know what to look for when I seek solutions and how to go about fixing things.  If I’m taking shots at individual stocks here and there, I have little opportunity to make things better if things sour.

So once again, bottom line, if you want to benefit from a good strategy, you have to own the portfolio of stocks produced as a result of the strategy. If you pick and choose, your strategy is out the window and it’s between you and Lady Luck.

So They’re Not Businesses but Just Pieces of Paper

Yes!!!!!!!!

That’s what they are, pieces of paper. (For those too young to remember paper stock certificates and who may, hence, not get this metaphor, think in terms of files on a hard and/or cloud drive.)

I don’t for one single nano-second feel even the tiniest bit guilty for not respecting these stocks as ownership of business enterprises. Yes, legally, that’s what they are. But that’s just a legal formality.

If I own a business, I want to be able to influence it. But I can’t influence any of the companies whose shares I own. (That’s why when takeover offers materialize, they are at a premium to the market price; i.e. they incorporate a “control premium.” A business you can run is worth more than a business in which you’re forced to sit passively on the sidelines and hope.)

Also, if I own a business and I need information on the company, I want what I want and I want it now! I don’t want to hear about disclosure rules, quiet periods, conference calls, and so forth. That’s for participants in the cold impersonal public capital markets. It has nothing to do with REAL owners. The capital markets are important. Without them, our standard of living would be unachievable. So in terms of social justification, I’m fine being a participant in the markets. What I’m not fine with is pretending to be involved with something different – the control and operation of a business.

There’s a very classic principle of law that directs courts to consider the substance of a transaction as opposed to its form. In form, yes, the shares I own represent partial ownership of business enterprises. In substance, they’re pieces of paper. And to protect my financial well being, I need to buy and sell based on what they’re worth in substance, as pieces of paper – pieces of paper with distinct quantifiable characteristics – but pieces of paper nonetheless.