My Investment Journey

[KnowThePast]

Have worked for WATPAK

If they don't have the contracts then they will continue to shrink to maintain viability.
Then when larger contracts come along they may find it difficult to gear up.

There is a reason their chart looks like this over the last 5 yrs.
And looked healthy 5 yrs prior.
And unless there is an expansion phase again in infrastructure then this is not going to out perform.

View attachment 54413


View attachment 54414

Thanks tech/a, it's great to get some inside knowledge of it.

I have to admit I am dumb when it comes to reading the charts, I look at fundamentals. In this case, they look about the same

Scaling down doesn't worry me too much, in fact, I like the fact they are able to do that.

They have $1.34b order book, compared to $1.48bn in revenues last year (which includes discontinued operations). Any idea how much of a pullback might be too much for the company to be able to scale down to, and still be able to cover fixed costs?

Thanks

KTP

 

[craft]

Hi craft,

Thank you so much, great advice as always. I've made an embarrassing mistake of just assuming it's all NCA.

But to my defence, some of it is! Their inventory is $60m in current, and $35m in non-current. Redoing my calculation.... Next year, we get, assuming $70m is realised for $95m of those assets, and writedowns are cancelled by some profits:
Current assets = $413.
Total Liabilities = $333m.

Yes, not quite a net net, but very close, unless there's a total meltdown in property prices and/or underlying business performance. I've allowed for a 25% reduction in property prices and $13m EBIT reduction.

KTP

The only way I could come up with those numbers is to double count the 70m you expect from realising the inventories in both cash and debt reduction.

How bout laying your calcs out long hand – so someone a bit slow like me can follow.

 

[KnowThePast]

KTP

The only way I could come up with those numbers is to double count the 70m you expect from realising the inventories in both cash and debt reduction.

How bout laying your calcs out long hand – so someone a bit slow like me can follow.

It's not you, it's me

I have reduced debt without decreasing cash. It's like that, I make one mistake, then try to correct it too quickly by making others.

Current Assets (discounted) - Total Liabilities are now at about break even, with PPP priced at about 2/3 of book value. Projected NTA @ $1.14, same as this year (doh!).

Still very cheap, but not by as much as I erroneously calculated before.

A very sincere thank you.

 

[odds-on]

Hi KTP,

Over the years, I have read a few investment articles which make the same excellent point about data inputs and prediction accuracy, the articles are based on studies of sports gamblers and their prediction accuracy compared to the number of data inputs they use in prediction. The studies show the more data the gambler has access to the more confident they are in their prediction; unfortunately they do not get more accurate after a certain amount of data inputs. Putting aside the whole gambling/investing discussion, there is a parallel to take into consideration when applying a “Buy Lots of Cheap Stocks” strategy – after a few data points an investor is probably not going to improve their accuracy rate, better to just create a sausage factory to churn these investment decisions out using a simple investment flowchart (James Montier has a good example in his book, Value Investing).

I found reading papers about the Altman Z Score and Piotroski F score, in conjunction with the Tweedy Browne literature, incredibly useful when I started thinking about applying a cheap stock strategy. There is a lot in those papers, especially if you compare it to reading about the cheap stocks investments of Buffett, Greenblatt, or another crafty investor – sometimes, it is as if they are purely playing the numbers and sometimes they are just being plain old crafty. Just be clear about drawing a line between playing the numbers and being crafty.

This thread is going to be an entertaining and informative read over the next couple of years, keep it up.

Cheers

 

[Klogg]

Hi Klogg,

That's absolutely correct - the company is now trading at rougly its liquidation value? So, I am asking myself - is this really such a bad company that it has no chance of future earnings and the best use of capital is to liquidate all of it? Really? There's hundreds of companies on ASX that are worse in every sense of the word trading at a much higher price.

I have to agree with what Oddson here - yes, there's plenty wrong with this company. Some things were mentioned, I could mention a few more myself. But it's trading at liquidation value, of course there's things wrong with it! But as a private owner of this business, bought at this price, what are the chances of me losing my investment?

You're right, it's trading a little below liquidation value as listed in their accounts. But your margin of safety just isn't there.

Assets are clearly overvalued if all they can return is 3% on the revenue generated. That being said, if you apply a reasonable margin on assets (as described in my previous post), you're left without a margin of safety.


Of course, the other thing to remember with an asset play is you need something to trigger the realisation of that net asset value. If management continue to run a business with these assets that has poor returns, the stock will continue to trade at a discount to its assets. Ofcourse, if they decide to sell up, then shareholders may benefit - chances of this is very slim IMO.

For what its worth, I made this mistake with REX. They trade well below NTA, have little debts and a decent cash pile, but the share price tracks that of its earnings. I didn't lose any of my capital, but there was an opportunity cost over those 15months.

 

[craft]

It's not you, it's me

I have reduced debt without decreasing cash. It's like that, I make one mistake, then try to correct it too quickly by making others.

Current Assets (discounted) - Total Liabilities are now at about break even, with PPP priced at about 2/3 of book value. Projected NTA @ $1.14, same as this year (doh!).

Still very cheap, but not by as much as I erroneously calculated before.

A very sincere thank you.

Ok

Cheap, but somewhere in the range from deservedly so to potentially opportunistically cheap I would say. Certainly No NET-NET can’t lose territory. So the real question and what I have been driving at in this thread – Was it worth breaking your rules for?

Even if you are ultimately right about it being cheap you have introduced timing risk. Will it have repriced in your time frame? If not you are going to be potentially ultimately right but still incur a loss to free up capital for investments that meet your long-term plan.

My objection is not about this sort of investing, I’m aware some do it and do it well and they do it from a fundamental valuation approach.

My objection is about breaking rules.

The market doesn’t dictate rules – its actually pretty boundless in the opportunities and risks it presents, especially if you add leverage. We make up the rules and guidelines to expose ourselves to some opportunity without exposing ourselves to the boundless risk.

Rules and guidelines should be made when we are at our smartest, most realistic about our skills and abilities, most relaxed and thinking holistically. We make them to protect and guide us when we are at our dumbest most stressed and narrowly focused.

If this type of investment fits within your holistic approach – write it into your rules and do the work and develop the skills to execute that form of investing well. – If not, let your rules stop you from jumping at potential mirages.

Passing on WTP may ultimately turn out to be a mistake of omission when viewed in isolation but a much bigger mistake of commission is ignoring your rules. I would rather miss a bit of potential profit from opportunity outside my rules then miss the outcomes of a well thought out and executed plan. To me this is a really important point for ultimate success – I guess why I keep responding to your detours from your stated plan, so having stated my point as clearly as I can I shall leave you in peace next time you bend the rules -promise.


Happy investing.

 

[craft]

He does add more on the subject, but it's probably better you listen to it yourself:
(http://www.bengrahaminvesting.ca/Resources/audio.htm - by the way, the audio download of Pabrai is also very worthwhile)

I believe this is what Craft is saying and it's a very important point.

I liked Russo’s concept of capacity to suffer.

 

[Klogg]

I liked Russo’s concept of capacity to suffer.

Reminds me very much of Fisher's approach (Common Stocks and Uncommon Profits) and he describes it quite well. His example of Nespresso really hit home with me, because I see them all around me now, but didn't know the company spent millions developing this beforehand...

 

[KnowThePast]

Ok

Cheap, but somewhere in the range from deservedly so to potentially opportunistically cheap I would say. Certainly No NET-NET can’t lose territory. So the real question and what I have been driving at in this thread – Was it worth breaking your rules for?

Even if you are ultimately right about it being cheap you have introduced timing risk. Will it have repriced in your time frame? If not you are going to be potentially ultimately right but still incur a loss to free up capital for investments that meet your long-term plan.

My objection is not about this sort of investing, I’m aware some do it and do it well and they do it from a fundamental valuation approach.

My objection is about breaking rules.

The market doesn’t dictate rules – its actually pretty boundless in the opportunities and risks it presents, especially if you add leverage. We make up the rules and guidelines to expose ourselves to some opportunity without exposing ourselves to the boundless risk.

Rules and guidelines should be made when we are at our smartest, most realistic about our skills and abilities, most relaxed and thinking holistically. We make them to protect and guide us when we are at our dumbest most stressed and narrowly focused.

If this type of investment fits within your holistic approach – write it into your rules and do the work and develop the skills to execute that form of investing well. – If not, let your rules stop you from jumping at potential mirages.

Passing on WTP may ultimately turn out to be a mistake of omission when viewed in isolation but a much bigger mistake of commission is ignoring your rules. I would rather miss a bit of potential profit from opportunity outside my rules then miss the outcomes of a well thought out and executed plan. To me this is a really important point for ultimate success – I guess why I keep responding to your detours from your stated plan, so having stated my point as clearly as I can I shall leave you in peace next time you bend the rules -promise.

Happy investing.

Hi craft,

What a fantastic post, deserves to be framed somewhere. It really helped me get some things straight in my head so today:

I've sold all my shares in PMP @ 0.33 for a $170 loss.

I was wrong, and greedy.

Main consideration was the fact that PMP is operating in a shrinking industry. As much as it may be undervalued at the moment, the longer the turnaround takes, the greater that value will deteriorate at that point. And while I still think the reward justifies the risk in this case, it is not for me. As you rightly pointed out, it violated to some extent every single one of my rules.

I've considered changing my rules, but it didn't feel right to change them in order to justify a specific investment. When I feel I want to get into things like that, I'll change rules first, then look for opportunities.

Thank you so much for you time, craft. Just because I am slow and my brain takes weeks to think through things, I do actually listen

I guess why I keep responding to your detours from your stated plan, so having stated my point as clearly as I can I shall leave you in peace next time you bend the rules -promise.

Please don't



Now, after all that thinking, I've looked at WTP again in context of my rules. Which were, as posted in the beginning:

I will look at (nearly) everything. But generally, I will only buy companies that have at least some of these:
1. I feel have every chance of being around and doing very well 20 years from now.
2. Company founder or long serving management on board, and owning a large stake in the company.
3. Consistently profitable over many years.
4. Acceptable or higher ROC.

While I may sometimes come across as a long term, "Buffett-style" investor, that was never my intention. It was always my intention to enter some less than stellar companies, provided adequate safety. WTP, I feel, fits into my investment criteria just fine:

1. While cyclical, the industry will grow long term in my opinion. WTP has as good a chance as any company in the industry to be around in some shape 20 years from now. Short/medium term they look better than many others, give how much cash they have/will have.
2. 3 long serving directors. 2 directors own close to a million shares each. Not a massive shareholding, but not trivial either.
3. Profitable in 9 out of the past 11 years. 2 years of losses are due to property division that they are no longer going to be involved in.
4. This is the only rule that doesn't fully stand up. But, ROC was very good prior to 2009, then property division greatly dragged down the result. Taking property division away, ROC is still not great, but not so bad that I want to run away screaming. Given that it is a cyclical industry, and not in the best of times, I would expect it to improve.

So, I'd say WTP meets my Buy criteria, about 3.5 out 4.0. My rules allow for some flexibility so I have no issue here.

What about things I won't invest in:
Things I generally won't invest in:
1. Things I don't understand, whether it is the business, the industry, or the annual reports.
2. Companies that are generally not profitable.
3. High debt.

1. No issues here, I understand them well enough, I think. I really liked reading their annual report as well. Described things in English, without much bull****.
2. As I wrote above, company has pretty much always been profitable. Writedowns of assets, while a loss, are mostly a sign of bad capital allocation than operating losses.
3. No more net debt as of last report, and will get even better with more asset sales.

So, in summary, I think WTP fits into my rules just fine.

 

[KnowThePast]

Hi KTP,

Over the years, I have read a few investment articles which make the same excellent point about data inputs and prediction accuracy, the articles are based on studies of sports gamblers and their prediction accuracy compared to the number of data inputs they use in prediction. The studies show the more data the gambler has access to the more confident they are in their prediction; unfortunately they do not get more accurate after a certain amount of data inputs. Putting aside the whole gambling/investing discussion, there is a parallel to take into consideration when applying a “Buy Lots of Cheap Stocks” strategy – after a few data points an investor is probably not going to improve their accuracy rate, better to just create a sausage factory to churn these investment decisions out using a simple investment flowchart (James Montier has a good example in his book, Value Investing).

I found reading papers about the Altman Z Score and Piotroski F score, in conjunction with the Tweedy Browne literature, incredibly useful when I started thinking about applying a cheap stock strategy. There is a lot in those papers, especially if you compare it to reading about the cheap stocks investments of Buffett, Greenblatt, or another crafty investor – sometimes, it is as if they are purely playing the numbers and sometimes they are just being plain old crafty. Just be clear about drawing a line between playing the numbers and being crafty.

This thread is going to be an entertaining and informative read over the next couple of years, keep it up.

Cheers

Thanks odds-on.

Still haven't read the Alt Z paper, my reading list keeps growing at a faster rate than I am reading, but I'll get to it eventually.

You're right, it's trading a little below liquidation value as listed in their accounts. But your margin of safety just isn't there.

Assets are clearly overvalued if all they can return is 3% on the revenue generated. That being said, if you apply a reasonable margin on assets (as described in my previous post), you're left without a margin of safety.


Of course, the other thing to remember with an asset play is you need something to trigger the realisation of that net asset value. If management continue to run a business with these assets that has poor returns, the stock will continue to trade at a discount to its assets. Ofcourse, if they decide to sell up, then shareholders may benefit - chances of this is very slim IMO.

For what its worth, I made this mistake with REX. They trade well below NTA, have little debts and a decent cash pile, but the share price tracks that of its earnings. I didn't lose any of my capital, but there was an opportunity cost over those 15months.

Hi Klogg,

I probably didn't explain my valuation of the company well enough in my original post, causing some confusion.

I do not think liquidation value, or even NTA or replacement value is necessarily the correct valuation in this instance. I believe the company will continue to operate profitably for many years to come, although it will have its cycles. There won't be any trigger to realize asset values, and it will usually be valued by the market by its earnings.

I've harped on so much about its current price been close to liquidation value not because I think that is what it is worth, but because I don't think it can be worth significantly less than that. That's essentially my margin of safety, that barring major disasters, it is difficult to see how one can lose money here, from a perspective of a private owner.

At this price, a lot of things can happen that would make the company more valuable in the eyes of the market, earnings may improve, new contracts may be won, a year or two of reported profits will change the perception of the company, etc. In contrast, there's are not that many realistic scenarios that would cause the price to fall significantly below current levels.

It is not a sure thing, but I believe my downside is limited in short/medium term, and at these kind of prices, good things tend to happen.

For everyone's enjoyment, some quotes from Walter Schloss that I really like:

- Earnings have a way of changing, and it’s far more fickle than assets.
- Something good will happen.
- I learned that if I can simply survive in the market, just like surviving in the war, and not lose money, eventually I will make something.
- If a stock is cheap, I start buying.
- When I buy a stock that is depressed it hardly ever turns around immediately.
- Anything terrible that doesn’t happen to you is profit!
- I felt that I was a grocery store owner, holding stocks as my inventory. Sometimes these stocks paid dividends, and so they were worth the wait. Eventually, someone would come along and offer a good price for my inventory, and I would sell.
- I always held 50 to 100 stocks at any given time because it would have been very stressful if one particular stock had turned against me.
- Use book value as a starting point to try and establish the value of the enterprise
- Don’t sell on bad news.
- Have a philosophy of investment and try to follow it.
- Try to buy assets at a discount than to buy earnings. Earnings can change dramatically in a short time. Usually assets change slowly. One has to know much more about a company if one buys earnings.
- I try to protect myself from permanent loss of capital by investing in stocks that are depressed.
- I like to buy companies with very little debt so it has a margin of safety.
- I like companies that sell near their book value.
- You have to do a certain amount of research.
- I don’t really focus on what the earnings are going to be next year, I try to protect myself and that I don’t lose money.
- A stock has lost half, and you go in and buy more. That is not easy. People will think you are crazy.

 

[Valued]

My problem with an asset play like WTP is that the assets are unlikely to be worth as much if the assets were actually sold. Further, I am of the belief that if you have assets you are never going to sell then they are only worth as much as the net income that they can generate. If a company is going to keep its land and its factories for 50 years and it's going to keep it's machinery until it dies well then the assets are simply worth the profit that they generate. If they are worth more then the future net profits then the company should just liquidate right now and disperse the money to shareholders.

I don't understand asset based investments for that reason. I have a significant amount of money (significant for me anyway) in a company trading over twice its book value as the net profit it will generate from its assets in the future exceeds the worth of the assets themselves.

I might be wrong though and perhaps in theory a company should at least reach its book value if it's generating a positive net income. If I end up losing money in the stock market at some point well then I will have to fire myself

 

[KnowThePast]

4 months update:

 

[KnowThePast]

My problem with an asset play like WTP is that the assets are unlikely to be worth as much if the assets were actually sold. Further, I am of the belief that if you have assets you are never going to sell then they are only worth as much as the net income that they can generate. If a company is going to keep its land and its factories for 50 years and it's going to keep it's machinery until it dies well then the assets are simply worth the profit that they generate. If they are worth more then the future net profits then the company should just liquidate right now and disperse the money to shareholders.

I don't understand asset based investments for that reason. I have a significant amount of money (significant for me anyway) in a company trading over twice its book value as the net profit it will generate from its assets in the future exceeds the worth of the assets themselves.

I might be wrong though and perhaps in theory a company should at least reach its book value if it's generating a positive net income. If I end up losing money in the stock market at some point well then I will have to fire myself

Hi Valued,

I think we are in agreement here.

I expect WTP to remain a going concern for many years. Since it does not hold any strong competitive advantage, I expect it to be worth roughly the reproduction cost of its assets.

A company generating less than average returns would need to be discounted, while the company with great management and above average returns may command a premium.

WTP, at first glance, produces returns that don't justify its cost of capital. But, with the sell off of its property division and focus on core business, I expect ROC to go up significantly. It is also operating in a cyclical industry, returns will fluctuate through the cycle quite a bit.

I value WTP at somewhere between NTA and reproduction cost of assets. I haven't properly calculated its reproduction cost of assets, but at the time of purchase, it was trading at a 40% discount to its NTA. This was a large enough margin of safety for me. Its strong balance sheet means I can sleep well while I wait for things to improve.

 

[Valued]

Fair enough.

I am a bit of a prude and only invest in extraordinary companies with big competitive advantages that I can see being sustained for at least five years. Of course, I then want a massive discount to its intrinsic value. Even if it may be profitable, WTP wouldn't pass my initial screen for the simple reason that I see below NTA price with a low return on equity and a low return on capital. It makes me think a write down is coming. If the write down does come and the share price plummets then I might consider buying. I don't like paying for sub-NTA stocks with low RoE and RoC since I can't sleep easy at night thinking there is going to be a write down.

It also doesn't help that I value WPT at around $0.60 per share if I am being bullish and more like $0.40 if I am being bearish. I am probably being quite conservative compared to you though. I demand massive discounts to intrinsic value unless the company is most extraordinary (for example, I would be likely to buy CBA if it were at even a small discount to intrinsic value).

 

[KnowThePast]

A new purchase, but first, a change of strategy. I was going to post about it earlier, but never got around to it. You’ll just have to believe me that strategy came first, not the buying.

I now want to allocate some of the capital to companies trading at a substantial discount to their assets. Most of these will be ugly in some way. While I expect these to have a high error rate, I am walking into this knowing that as a group, these opportunities provide returns above average.

Eventually, I see myself playing in this area more and more, but for now, some rules to restrict me:
- No more than 20% of my capital
- Invest $1000 (2%) at a time, but look to average down at 20%+ discount once, occasionally twice.
- I have a set trigger to sell at a profit, but won’t disclose it here, sorry.
- I will give each trade 3 years to make a profit. Exceptions will be made when the entire market is in decline.
- Prefer Net Debt/Equity less than 50%.
- Prefer solid business/industry in trouble, rather than shaky business models.
- Try to avoid the really dreadful once.

So, with the above in mind, I bought BOL, 5000 @ 0.20.

It’s an average business, in a bad state, in the wrong industry, in a bad part of a cycle, with bad (stock market) reputation. The only thing worse is its share price, although it’s already substantially improved from a few months ago.

Net of all liabilities, they have $313m of assets that they struggle to deploy in ways to earn an adequate return. Current market value, is $94m. They can essentially throw away half of their Net Assets, and still be worth the current price, in theory. Tangible assets are $238m.

They’ve already announced, again, more redundancies. And sale of some old, unused cranes for ~$10m. Focus is on retiring debt, than initiating a buyback.

I won’t focus much further on the immediate picture, at these prices, two things are key for me.
1. Their services are going to be needed in the long term, therefore their assets have value that competitors will need to buy/replicate. Temporary contractions in demand may mean that over-leveraged businesses such as BOL may need to shrink, but I think the price differential allows for a lot of value destruction before earnings equilibrium is reached.
2. They can survive the short/medium term. Their balance sheet is rapidly getting better, cash flows are positive, cap ex is expected to reduce, personnel reduced, asset sales will help. Furthermore, I expect that market would still tolerate a capital raising or two, should there be temporary “liquidity” problems.

This is very much a statistical play, which I know will work in my favour often enough. Main thing I am trying to do here is not so much to pick the best opportunities, but avoid the worst ones. This is certainly not an investment for the long term, quality growth oriented investors.

 

[KnowThePast]

5 months update:

 

[odds-on]

5 months update:

View attachment 55052

Hi KTP,

I notice WTP is now trading above a $1.00. Are you tempted to sell?

Cheers

 

[KnowThePast]

Bought BYL. 6000 @ 0.34.

This is a very similar company to NWH, and I bought it for exactly the same reasons.

It is very cheap by juts about any metric. It is in a business where I expect long term demand to increase and I believe it will survive any short/medium term fluctuations.

Original founder is on board, a few directors own lots of shares.

Their cash balance/debt are not as good as NWH's, however, most of that debt is equipment leasing.

Not much more to say, really. I'll know if I'm right about the industry outlook in a few years.

 

[KnowThePast]

Hi KTP,

I notice WTP is now trading above a $1.00. Are you tempted to sell?

Cheers

Hi odds-on,

No, it is still nowhere near what I would call overvalued. In fact, I could probably still make a case that it is worth buying at these prices.

 

[KnowThePast]

Is value investing dead?

Warning - lots of words and numbers to follow.

I've mentioned before that I use my software development skills to help me with investing. I thought I'd share what I do and how I go about it.

A topic that's always been of great intrest to me was backtesting based on fundamental analysis. There is already a lot of great literature on the subject, such as "What works on Wall Street" by James P. O'Shaughnessy and "What has worked in investing" by Tweedy, Browne. Ben Graham and Seth Klarman were also proponents of semi-automated stock picking strategy, among many others. Reading all these works have been of tremendous benefit to me, and is the backbone of my investment strategy. I have always felt, however, that there are some unanswered questions. They may lead to the same answer, but I always wanted to ask. Such as:

1. Most studies base strategy on buying at a particular point in time, then rebalancing at a particular point in time. Usually going from lowest to highest. That is, backtest on Low EPS strategy would rebalance portfolio based on stocks with lowest PE once a year, or so. This would be fine for a fund manager who can accumulate all stocks meeting criteria. Not so fine for a smaller investor such as myself, that will probably buy only a few stocks and not once a year, but when an opportunity comes up.
2. Not many studies based on Australian stocks.
3. Knowing how a strategy works across an entire market is very useful, but even more useful is knowing how it works across stocks that I personally am interested in. For instance, I don't invest in mining and biotec specs, startups with no earnings history, companies with chronic debt/acquisition problems, etc. This is very personal and no automoated filter can be setup for this. Basically I want to backtest just on stocks I am interested in, this is very specific to my style/situation.
4. What about portfolio management? Some things that may make a big difference are averaging down/up, selling losers, limiting number of purchases per month/year.
5. What if you have limited capital? What percentage to allocate to each purchase? How long to hold for? When to sell? What if I want to combine multiple criteria, and possibly have different ones for buy and sell?

Overall, I wanted a system that would allow me to setup an algorithm that would step through, historically, day by day, and make buy/sell/topup decisions as I would, in real time. At the time, I couldn't find anything that met the criteria, so I built my own.


The first test of the system, was, of course, the classical Ben Graham approach - buying companies at below asset value. Does that approach still, statistically, make money, even though it's been known about for many decades? Below are my ramblings on it.

DISCLAIMER: This post is for discussion only. This is not a system I use, nor do I recommend it to anyone. There's lots of things that could throw an error here. It is based on my own list of ~230 companies, filtered based on nothing but my own opinion, there's some survivorship bias, there may be bugs/data errors. I repeat, this test is done on a very specific set of data. Doing it with a different data set is likely to produce different results.


For the purpose of this exercise, all backtests will be:
a) Run for the last 10 years, 01/11/2003 to 01/11/2013
b) based on ~230 companies in my watchlist. These include some companies that have since been delisted, but not all, so there is some survivorship bias. Most of these are companies with at least a few years of generally profitable operations.
c) no dividends included
d) $10,000, or 2% of portfolio parcels, whichever is greater. $30 brokerage, based on closing price, no slippage.
e) backtest will step through on a monthly basis. Each week, it will evaluate current holdings to see if any meet the sell criteria. It will evaluate all companies to see if they meet the buy criteria.

First step is to establish a benchmark.
XAO returned 69.4%.
The proper benchmark, however, is simply buying all the companies that I will use in the backtest and holding on to them. This returned 158.04%, and will be used as the benchmark.

Criteria for Buy will be Market Value compared to Total Assets. I will break this down into multiple backtests to show the results based on discount size.
Criteria for Sell will be Current Market Value > Net Assets X 3.
No averaging up/down.



A strong correlation between asset value and return, especially at the lower end. Buying at below 0.25 P/B shows massive returns, but there were only 26 trades over 10 years. Given that I am already using a cut down data set, this simply isn't enough data to treat as reliable evidence. Nevertheless, my results showed what other studies have shown over the last few decades - buying at lower book values tends to give better returns. And the lower you buy, the better. What's also interesting is that the success rate has not changed by much in each test, if anything, it improved with lower value P/Bs, which would normally be considered riskier.

Let's now take it further. For buy criteria, I will use P/B < 0.70, as that is the value at which the test above returns above the benchmark, at 236.41%. Time to play with sell criteria:



There seems to be relatively little difference whether to sell at PB>1 or PB>5. However, selling sooner would have tax implications, which are not accounted for here. Also, my capital is limited and I do not have enough funds to buy everything that meets the criteria. So let's make changes to accomodate me. Capital will be restricted to $250,000, 2% per trade, so that is only enough initial capital for 50 trades. Because we now won't be able to buy everything that matches that criteria, companies wll be ordered by P/B. The lowest ones will be chosen. This should give us an idea whether it is better to recycle the funds, or stay invested once bought. Let's now re-run the tests above with these changes.



Tests above confirm that it's better to sell holdings before they become too expensive, but just at what price is a lot less clear. The higher you go, the more capital is tied up for longer. Also, at P/B > 5, there's only 49 trades, as most of the capital was tied up in the first few years and no cash was available to buy opportunities available later.

My take on it is that this is one of the many things that can't be automated. Selling at P/B of anywhere between 1 and 4 would make sense, depending on the number of new opportunities available and cash needed.

Let's go on.

I'll use P/B < 0.7 as buy criteria and P/B > 2 as the sell criteria for future tests. P/B > 3 shows a slightly better result, but I prefer a lower one as it results in more trades, and the result is less likely to be attributed to a lucky few trades.

On of the more surprising things to me was that the success rate was consistently above 70% for all tests. Nevertheless, I would think it prudent to pick safer companies, with better metrics. Even if it doesn't improve the result, it should lower risk. So let's try a few things to see if we can improve the result, such as net debt/equity, ROC, OCF. Admittedly, this is not a good test for this data set, as it is already mostly made up of more solid companies.



Amazingly, none of these show any positive contribution to either risk or return. But again, it must be stressed that my data set is already heavily skewed towards "safer" companies. Checking for positive operating cash flow over 5 years gives a slightly better result, so I'll use that as the benchmark going forward.

As the success rate is quite high, it would be reasonable to assume that averaging up/down should give a better results. Let's try a few different tests. Original buy criteria will be checked when topping up, no averaging on deteriorating fundamentals in other words.



As expected, averaging does produce a better result. What's less expected is that averaging up produced better result than averaging down. Let's now keep averaging up, 20%, twice, as the new benchmark.

I am limited to how much I can post in one entry, so I will continue in the next post.