The Ultra-Value Investment Portfolio

The purpose of this blog entry is to run a simulation of value stocks.  Being a CFA candidate as well as an avid investor, I have always been more of a value investor rather than a growth investor.  I have always believed in the principle that many financial markets obey certain laws that that, ultimately, all values converge towards the median.  This is especially true with the law of large numbers, the more stocks we include in a portfolio, the more likely the portfolio as a whole will converge towards equilibrium.

Many years ago, I had the opportunity to test this theory with a stock simulation program which allowed you to test a portfolio against other participants.  Since I was studying portfolio management, I wanted to test the theory that a value portfolio using stocks that had very low P/E ratios can outperform most of other portfolios.  By looking at a list of stocks and selecting the lowest P/E stocks, I was in fact able to outperform as many as 95% of my peers in the simulation.  A great deal of time has passed and we have a great deal of additional information available to us in which we can not only reach out to a wider equity market, but we can also gather more information in order to test theories.

The Ultra-Value Investment Portfolio

What I wanted to do was run a simulation of a portfolio which was made up of value stocks were both cheap in terms of earnings, but still robust enough to survive.  The Portfolio was going to have a value of approximately $100,000.00.  Since I had no preference over any stocks I wanted to weigh them all equally.

The parameters were as follows

1/ The P/E (Price Earnings) ratio had to be low.  In this case, under 15
2/ I wanted to avoid extremely speculative stocks and wanted to focus on small cap stocks which I believe would have the potential to grow faster.  The Market Caps I selected were both small and Micro.  This would include companies with a Market Capitalization between $20 Million and $300 Million.
3/ the stocks had to be financially robust with a viable asset base and no crippling debts.  I would only include stocks which had a Quick Ratio (Current Assets over Current Liabilities) over 1.
4/ the stocks had to trade on the NYSE

When I ran the values in the stock screener I was given 15 stocks.  I figured that this would be an acceptable number since it would be diversified enough to reduce any company specific risk that might exist in the portfolio.

The stocks, in order of rising P/E ratios were as follows.

Ticker	Company	Industry	Country	P/E
BORN	China New Borun Corporation	Beverages - Brewers	China	1.22
ZA	Zuoan Fashion Limited	Textile - Apparel Clothing	China	1.74
XNY	China Xiniya Fashion Limited	Textile - Apparel Clothing	China	2.29
CGA	China Green Agriculture, Inc.	Agricultural Chemicals	China	2.3
SRI	Stoneridge Inc.	Auto Parts	USA	3.79
TGS	Transportadora de Gas Del Sur S.A.	Gas Utilities	Argentina	5.93
BTH	Blyth, Inc.	Personal Products	USA	7.11
STV	China Digital TV Holding Co., Ltd.	Application Software	China	9.08
GGS	Global Geophysical Services, Inc.	Oil & Gas Equipment & Services	USA	9.42
KAI	Kadant Inc.	Diversified Machinery	USA	9.46
CO	China Cord Blood Corporation	Medical Laboratories & Research	Hong Kong	9.74
UFI	Unifi Inc.	Textile Industrial	USA	12.2
CFI	Culp Inc.	Textile Industrial	USA	12.7
REX	REX American Resources Corporation	Specialty Chemicals	USA	13
ARSD	Arabian American Development Company	Chemicals - Major Diversified	USA	14.4

This represented 8 stocks in the United States, 7 in China (including Hong Kong) and 1 in Argentina.   Even though it should be no surprise that the majority of the stocks were in the two largest economies in the world which together account for approximately 31.4% of global GDP, I would have preferred more geographical diversification.  There was some more variation in terms of industries but one can see that the textile industry weighed heavily with 26.66% of the portfolio being textiles.  This should come as no surprise since the Textile industry, as well as the energy and oil and gas industry, are traditionally value stocks.

Having created my portfolio, I will now monitor it and see how it performs relative to the broad market.  Over time I may choose to eject stocks that have a P/E ratio which rises above the 15 threshold in order to preserve the initial parameters.

I would like to add that this portfolio is purely an academic exercise and is in no way an attempt to sell any of the stocks mentioned above.  Over time I hope to gain insight as to how such a portfolio would perform in the market. 

Things that may be available sooner than we think

“The future ain’t what it used to be”

Yogi Berra

Growing up there were many ideas that we thought were futuristic.  Some were given to us from science fiction writers who had a vision of the future, some by futurists who believed that technology was going to evolve to a point where our way of living was going to be transformed.  Some seem to be wildly off the mark (the flying Delorean from the “Back to the future franchise” springs to mind).  But some seem to be coming to us sooner than we think.  Here is a list of concepts that I believe will be made possible in the relatively near future. 

Full automation:  Manufacturing has been transforming extremely rapidly in the past few years.  Following the Second World War, most manufacturing was focused in North America and was a very labor intensive model.  Manufacturing is now moving offshore to low cost producers.  Recently it was in China, but even more recently manufacturers are moving to even lower cost producers than China.  But what if we were able to take away the human capital from manufacturing?  Technology in the field of automation would make human labor a thing of the past and factories would be completely self-automated.  Imagine a factory being run with only one human overseer (if even that) while still able to run efficiently and with a degree of perfection that humans cannot perform.  Already we are seeing manufacturing being performed by 3D printers which can potentially allow someone to build something in their own home.  Robots begin to take over more roles that have been traditionally done by people.  

Remember that we make more food today with only 2 percent of the working population devoted to agriculture than we did when 90 percent worked in agriculture.  Manufacturing seems like the next logical step.

Virtual Reality:  The first steps have begun already.  Online media outlets (like Facebook and LinkedIn) enable people to live networked and online without the need for physical interaction.  We already create virtual worlds as seen by the popularity of online sites such as World of Warcraft and Second Life.  Goggles already exist which would allow someone to experience an online world in full 360 vision.  Technology is gradually moving to the point where virtual worlds can be experienced in all 5 senses, not just sight and sound.  A Matrix-like reality that seems indistinguishable from the real world and can fool the brain into thinking it is real.  At the rate we are going we should see the first iterations of this in the next few years. 

Less Physical stuff:  Books become converted to PDF’s, music and movies get downloaded rather than sold in CD format.  Family photos are archived in digital format.  Paintings can be portrayed on digital screens (and changed depending on the whim of the home owner).  Computers that were once the size of a living room are shrunk down to the size of a pamphlet.  TV’s which you can fold up and put up like a poster.  An “Omni tool” which will replicate an entire workshop of tools by morphing into different shapes, depending on the need.  People can move to a new country with one suitcase.  People stop buying cars because the public transportation system covers an entire city in an efficient transportation grid.  Print newspapers and magazines become extinct. 

Infinite Energy:  Already countries around the world are groaning under the need to supply energy to a rapidly growing world.  The Pentagon issued a statement a number of years ago that Energy independence should be a strategic priority for the United States.  Using military power to secure energy sources becomes more difficult over time.  Countries like China and Japan compete for resources in the South China Sea.   The traditional resources based energy economy becomes more obsolete.  New energy sources need to be found.  Mini- Nuclear power plants supply power to individual cities.  Solar power plates the size of Arizona can float in space and send back energy via microwaves.  Geothermal power harnessed directly from the Earth’s core.  Wind power fields that cover New Zealand and become the new “Saudi Arabia” of renewable energy.  Fission technology which would split atoms and allow a glass of water to power a city. 

In addition to providing more energy, our society would simultaneously find ways to use less.  Energy efficient cars, energy efficient homes, and other improvements make our energy footprint smaller. 

Unlimited Food:  This really ought to be possible now.  Given the improvements in food technology there really should be efficient means to provide nourishment to the entire human population. 

End of Poverty:  Given improvements in healthcare, medical care, nourishment, and the ability to provide basic services and staple goods at a low price, eventually there should be an end to what we call poverty. Sure income inequality will not disappear, but societies will be able to provide a bare minimum living standard which will allow individuals to live at a decent level.  

Power Armor:  This refers to soldiers going into combat with futuristic armor.  Already there are articles about exoskeletons which allow soldiers to carry heavier loads.  As time goes by, armies are becoming smaller, more high tech, and more professional.  Mass conscripted armies give way to smaller leaner fighting forces which are much more elite.  Look at the proliferation of Special Forces activities in the US army.  Political will is becoming less tolerant of human casualties in a world of universal media.  Imagine soldiers similar to Iron Man or Space Marines.  Already there is talk of uniforms which allow soldiers to become invisible.  Imagine soldiers who can go to war completely bulletproof. 

Droid Armies:  The “Drone wars” are already making this a reality.  Drone pilots can fight a war in Afghanistan in the comfort of an office in Nevada.  Politically this has advantages because you don’t need to write a letter to the drone’s mother when one gets shot down and it creates less outrage.  Robots can go into dangerous situations that humans would be hesitant to enter. 

Cashless Society:  With the proliferation of Credit cards, debit cards, online banking, and online shopping, this will be more a reality as time goes by. 

Flexible Careers:  The age of specialization is a fairly recent chapter in human history, probably starting around the time of the industrial revolution and the rise of capitalism.  A few hundred years ago it was common for a well educated gentleman do to everything (hence the term “renaissance man”).  These days, professions are becoming increasingly obsolete because 1) they are being outsourced to lower cost centers or 2) they are being replaced by computer programs or automated.  Factory workers see that their factory moves to Mexico, a lawyer sees that his job can be automated and/or replaced by a paralegal.  A tax accountant sees that more people are using tax software during tax season.  A doctor in India can read a person’s diagnosis and send back a report to a client in the United States, at a fraction of the cost that a US doctor would charge.  A check out clerk at a supermarket is replaced by a machine which allows people to check them out.  People are already changing careers an average of 7 times in their lifetime.  In the future work will be more modular.  Rather than embark on a chosen career path, people will have flexi careers where the emphasis will be adaptability rather than a rigid dogma. 

More Egalitarianism:  The spread of the internet has allowed grass roots movements to organize more effectively.  Look at recent cases of the Occupy movement on Wall Street and the Arab Spring in the Middle East.  Protests have the ability to spread and morph at a rate unprecedented in human history.  People will demand a more equitable spread of wealth.