Value Stocks

How to Build a Portfolio of Value Stocks

First and foremost, to those who are not aware, I would like to say how I started my journey with value stocks – at least the practical aspects of  picking stocks. Initially I was a “dig deep”, “explore the balance sheet”, “learn everything about the company” kinda guy. This used to consume a lot of time and I would run into a lot of false positive ideas. Everything would be fine with the company except blah blah blah. It was very tedious to put into so much effort into analysis and come up with duds.

As my experience with investing began maturing, I realised that deep analysis is not completely necessary. I moved on to simple ways of screening for value stocks.

I realised that rigorous analysis is necessary only for a concentrated portfolio. For a very diversified portfolio, just simple graham rules are enough.

The last time I wrote on this topic, I said

As for deep analysis of annual reports – here is an outrageous and unconventional thought. I am convinced that reading annual reports and doing deep analysis for Graham kind of portfolio is not only unnecessary but could actually prove to be counterproductive!!!

The more I gained experience with investing and stocks, the simpler my stock selection mechanism became. I started diversifying more as well. It has been many years since stopped I reading annual reports while researching new stock ideas and so far I have not regretted it. I no longer “hunt” for value – I look for “obvious” value.

In fact about three years ago I hit upon a simple rule – I call it the 60 second rule. Given any stock, I had to make up mind within 60 seconds whether I would reject it. For the last three years I have used this very successfully.

Value-Stocks

I typically use these rules:

P/E < 5 Current price less than half of 52 week high Debt/Equity < 1 No losses in the last 5 years P/B < 1 One might think that such a method would be stupid, reckless, dangerous and inadvisable. To me, this was one of the best decisions I ever made about stocks and investing. Using the 60 second rule meant that the  value proposition of the stock should  be so obvious that I felt there was no necessity to dig deeper for margin of safety. I needed to feel a tinge of greed and hurry to go and buy the stock – the value had to be so obvious. It is not that I immediately buy within 60 second of encountering a stock – its just that the “proceed further” or “junk it” decision is taken within this time frame. I might even spend a couple of days making sure that the data I am looking at is the correct one. Many a time I have seen that financial portals give incorrect information (due to corporate actions, split etc.). Anyways, back to my actual method of putting together a portfolio of value stocks. I keep two things: a list of universes for stocks and a list of strategies. The list of universes I use are BSE 200, BSE 500, NSE 500, BSE Midcap, BSE Smallcap and a custom list called “interesting” where I keep adding companies I find interesting. The strategies I use are quite simple as well and nothing earth shattering: Low P/E, Low P/B, High Dividend Yield, Magic Formula, Modified version of magic formula, ROA/P/B and a couple of variants. I now apply these strategies against the list of stocks and look at the output. I look at top 10% of stocks for each strategy for each list for investing ideas. For instance, I would look at top 50 stocks of BSE 500 as per magic formula. Then I would look at 50 stocks with the lowest P/Es. I also screen stocks for 24/36 month lows – this is an involved process and not quite necessary. The strategy I really love is magic formula – it has worked amazingly well. Not just for smallcaps but for midcaps and largecaps as well. When going through these lists, I am almost always amazed at how plentiful “obviously value” stocks are in India. So far,  I have always had more ideas than I have had capital. I feel lucky that I don’t have to apply my skills in a more efficient or developed market where one really has to hunt for stocks. Just by applying magic formula to wide and varied set of “list of stocks”, one can easily construct a diversified portfolio of value stocks. How diversified? How much ever diversified you care to be! Such a list also told me another thing. If I couldn’t find as many value stocks as needed to build a diversified portfolio, the market was overvalued! I had to look no further than my own screening mechanisms to find if the market is approaching the red zone.

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