The Quality Value Investing Model | Part 1 of 2
Striving to study and learn in the short term as we save and invest for the long term
Summary:
Quality Value Investing focuses on owning slices of well-managed companies with durable competitive advantages.
In practice, quality and value-driven investing screens for enduring companies that create value for stakeholders.
Equal-weighting portfolio holdings can lead to market outperformance and limit investment decision bias.
This two-part post examines how the profitable retail common stock portfolio resembles a collection of owned slices of well-managed companies producing in-demand high-quality products or services with enduring competitive advantages.
Alpha happens when investing in wonderful companies over enduring periods instead of the shortsightedness of trading in and out of faceless stocks.
Screen for Quality, Enduring Companies
Quality Value Investing aims to create value for readers by centering on how to screen, research, and select potential ownership slices of publicly traded companies offering enduring legacies to stakeholders, inclusive of customers, employees, vendors, suppliers, regulators, the community at large, and present or future shareholders.
Wall Street lives and dies by its quarterly earnings releases and the fanfare preceding and following each report. However, forecasting future stock prices, market movements, revenue growth, or earnings per share with consistent accuracy is arbitrary, even for senior management of a company. Never attempt to predict in detail what will happen with the stock market or any particular business. Instead, screen, research, and monitor quality businesses for mispriced value.
Strive to study and learn in the short term as we save and invest for the long term.
The lesson for quality-driven investors is about owning slices of excellent companies instead of trading speculative instruments. This post answers why and how putting quality before speculation is the more profitable approach to retail investing.
Quality Value Investing’s proprietary checklist offers a model to screen for the bargain-priced shares of companies with strong value propositions, positive topline growth and net profit margins, adequate returns on equity and invested capital, favorable earnings and free cash flow yields—as compared to the Ten-Year Treasury rate—attractive prices to sales, operating cash flow, and enterprise value to operating earnings, controllable long- and short-term debt coverage, and low share price downside risks.
As such, we are investing in the facts of a company’s current wealth and a stock price’s present value.
A higher potential for market-beating performance exists when a company and its common shares are superior in each screening indicator. Quantify the performance of the operation in more objective than subjective terms.
No-brainers are better bets than possiblys or maybes.
Instead of chasing the dragon, own common shares to savor the benefit of partnering with a company supporting its customers with in-demand, useful products or services, rewarding employees with sustainable career opportunities, and compensating shareholders with positive returns protected by world-class internal financial controls.
High-quality companies offer the best opportunities for our portfolios to outperform the market on the downside, with a lesser percentage drop than benchmark index averages. Senior executives of varying qualities will come and go when least expected. Therefore, stick with companies that hold enduring quality and value.
Seek companies with overall attractive long-term prospects, as the durable competitive advantages of the operator remain paramount to the success of the investment over time.
Stop making bets on faceless stocks and start investing in quality companies.
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Buy Shares When Available at a Discount
Any stock surviving our screen qualifies for additional research, potential real-time purchase, and active inclusion in our portfolio.
The stock screen used to construct the QVI Real-Time Stock Picks favors the protocols of finding stock price value from wide safety margins, then profiting from price and dividend compounding driven by high returns on management’s capital allocations.
For value-driven investors, an attractive stock price becomes a non-negotiable prerequisite to initiating the productive partial ownership of quality companies. The preservation of capital becomes supreme following the stock purchase.
Patient everyday stock investors know if they wait long enough, their targeted quality companies—including some already in their portfolio and now trading at higher valuations since initial purchase—become available at bargain prices, if only temporarily. Consequently, investors or traders who lack patience often pay more for the equities purchased. Why pay more?
Investors who hold a concentrated basket of the common shares of high-quality companies and follow it with diligence have an increased potential to produce superior returns over the long term. On the contrary, we’ll lose more often than win by trading in and out of stocks based on news, quarterly results, or market sentiment.
Frustrating as it is, owned equities held in a portfolio or targeted common shares on a watchlist more often appear at fair value or overvalued to investors focused on owning the mispriced stocks of enduring companies over long-term holding periods. Practice discipline and patience to keep sifting for value regularly as the occasional surprise bargain appears when least expected. Buy the common shares of a targeted, high-quality business when the market turns against it, thereby generating a reasonable, if not bargain, price point.
Remember, value-driven common stock investing is the equivalent of finding the proverbial needle in a haystack and, therefore, requires large doses of discipline and patience for long-term success. Wait for the valuation multiple of the shares of an enduring enterprise to drop to levels signaling a temporary bargain.
Keep your eyes open to avoid blinking and missing those excellent yet fleeting buying opportunities.
Conscientious investors never wish for macro or microeconomic events that negatively affect jobs and portfolios. When one occurs, the available dry powder gets allocated to the discounted stock prices of quality companies that often ensue. One cannot change history, only one’s reaction to it. Stick to the basic tenet of the value-driven investor’s search for alpha by focusing on a stock’s attractiveness based on valuation metrics relative to the underlying fundamentals of the business.
Elude the prediction game of specific future margins and cash flows. Instead, uncover great companies trading at reasonable prices based on diligent research and analysis of the current wealth and present value. Remember, in the stock-picking vehicles of rational, disciplined, and patient investors, the rearview and side-view mirrors are clear, and the windshields are foggy. So, invest with due diligence based on looking at the rear and side views and deploying common sense and instinct instead of looking forward through the windshield of the unknown or into a crystal ball.
Is this a company we'd invest in if owned as a private enterprise by a friend who asked us to become a partner?
Concentrated portfolios of select quality compounders purchased at reasonable prices are the best opportunity for success in long-term, do-it-yourself common stock investing.
Equal Weighting Our Portfolio Holdings
My 20+ years of investing experience and market observations have whittled down to cultivating an equal-weighted basket of the common shares of quality companies purchased at reasonable prices, then holding for an extended duration with the objective of most stocks outperforming the market.
Quality-driven investors treat each component equally regardless of price, market cap, or market sentiment by equal-weighting their portfolio.
The Concentrated and Expanded Real-Time Stock Picks are equal-weighted. Each holding has the same pro-rata amount invested against the broader market benchmark, the S&P 500, based on the initial stock purchase dates or the original publication of the underlying research. Total return represents the stock price performance adjusted for splits and dividends.
Assuming equal allocation, if four or five out of six ideas are profitable, the winners offset or at least cover the losses from one or two bad ideas.
Various weighting mechanisms exist, such as price-weighted, equal-weighted, and fundamental-weighted. For example, the Dow Jones Industrial Average uses price weighting, where the higher-priced components receive the maximum weight. Equal weight treats each constituent the same regardless of price or market cap. Fundamental weight employs sales, book value, dividends, cash flow, and earnings metrics.
The two universal portfolio weighting mechanisms are market-weight and equal-weight.
Although controversial, the use of market-cap-weighting dominates portfolio weighing mechanisms. Market cap, or capitalization-weighted indexes, assign component value by the total market value of the outstanding shares against the cumulative market cap of the investment basket. Thus, the largest market cap stock in the portfolio has the most significant influence on overall performance. Market capitalization is the closing share price times the number of common shares outstanding.
Remember that portfolios using a market-cap-weighted allocation equates to following the crowd, as the higher the market cap, the more popular the stock. Thus, the equal weighting of our portfolios is the best measure of overall performance against the benchmark.
The S&P 500 Index—the QVI Stock Picks benchmark—is free-float market-capitalization-weighted. This method assigns a factor to each stock to account for the proportion of outstanding shares owned by the general public instead of shares held by the government or company insiders.
To equalize the weight of our portfolio, buy the same amount of dollars per holding or counterweight using the same number of shares in different dollar amounts. Despite being partial to the stocks purchased, we never know what holdings will outperform the benchmark in the long term. To maintain equal weighting in our portfolios, remember to rebalance at least once yearly by reducing the winners and adding underperformers meeting our valuation criteria. Or better yet, go with the winners and reduce or eliminate the losers.
Equal-weighting has worked well for the QVI Real-Time Stocks toward their alpha-achieving market outperformance.
Attempting to bet on what specific stocks or ETFs in our portfolios will beat the market over an extended holding period is akin to predicting what teams will win the Super Bowl, World Series, or March Madness in 2030. Placing a speculative wager is perhaps the best we can muster. Unfortunately, making bets and crossing fingers is the antithesis of rational, disciplined, and patient quality value investors.
Suppose we purchase reasonably or bargain-priced stocks of well-managed, shareholder- and customer-friendly companies with excellent competitive advantages and palatable downside risk. In such cases, the prospect is that most of the holdings outperform the benchmark over time. Also, by equal-weighting, there is no need to overweight by speculating what holdings will exceed the targeted market standard.
Consider equal-weighting portfolio allocations to bypass the speculative trap of trying to predict what holdings will perform best over time. Instead, forever practice responsible portfolio management with well-planned and executed allocations of available resources.
Ultimately, the equal weighting of our portfolios increases the likelihood of outperformance by limiting conscious and subconscious bias.
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